Corporate Risk Management

Foreword by Denis Kessler xiii Introduction xvii General Presentation xvii Contents of the Book xix Acknowledgments xx General References xxi Chapter 1 Risk Management: Definition and Historical Development 1 1.1 History of Risk Management 2 1.2 Milestones in Financial Risk Management 3 1.3 Current Definition of Corporate Risk Management 7 1.4 Conclusion 8 References 9 Chapter 2 Theoretical Determinants of Risk Management in Non-Financial Firms 11 2.1 Value of Risk Management 12 2.2 Comparative Advantages in Risk Taking 16 2.3 Risk Management and Capital Structure 17 2.4 Risk Management and Managerial Incentives 18 2.5 Conclusion 19 References 19 Chapter 3 Risk Management and Investment Financing 21 3.1 Basic Model 21 3.2 Illustration with the Standard Debt Contract 27 3.3 Model with Two Random Variables 28 3.4 Conclusion 31 References 31 Appendix A: Value of dI*/dw 31 Appendix B: Standard Debt Dcontract 32 Chapter 4 Significant Determinants of Risk Management of Non-Financial Firms 35 4.1 Rationale for the Research 35 4.2 Significant Determinants 36 4.3 Governance and Endogeneity of Debt 50 4.4 Conclusion 60 References 61 Appendix: Construction of the Tax-Save Variable 62 Chapter 5 Value at Risk 63 5.1 Example of VaR 63 5.2 Numerical Method 65 5.3 Parametric Method 66 5.4 Taking Time Periods into Consideration 67 5.5 Confidence Interval of the VaR 68 5.6 CVaR 69 5.7 Conclusion 70 References 71 Chapter 6 Choice of Portfolio and VaR Constraint 73 6.1 Optimal Benchmark Portfolio of the Firm 73 6.2 Optimal Portfolio of a Constrained Manager 75 6.3 Conclusion 77 References 77 Chapter 7 VaR in Portfolios of Assets and Options 79 7.1 VaR as a Risk Measure 79 7.2 Models without Derivatives 80 7.3 VaR with Options 85 7.4 Black and Scholes Model and Risk Management 88 7.5 Delta-Gamma VaR 90 7.6 VaR of a General Portfolio 90 7.7 Application 92 7.8 Conclusion 97 References 97 Chapter 8 Conditional VaR 99 8.1 Motivation for CVaR and Coherence in Risk Measures 99 8.2 Notation and VaR 101 8.3 Definition of CVaR 104 8.4 Another Way to Derive CVaR with a Return Distribution 107 8.5 Example with Student's t-Distribution and Other Examples 108 8.6 Conclusion: CVaR in Basel Regulation 111 References 111 Chapter 9 Regulation of Bank Risk and Use of VaR 113 9.1 Basel Accords 114 9.2 Market Risk Regulation of 1996 120 9.3 Specific Risks 120 9.4 Total Required Capital 122 9.5 Tests 124 9.6 Comparison between Standard and Internal Methods with Interest Rate Risk 124 9.7 Conclusion 133 References 134 Chapter 10 Optimal Financial Contracts and Incentives under Moral Hazard 135 10.1 Optimal Financial Contracts and Moral Hazard 136 10.2 Theoretical Model 140 10.3 Empirical Application to Air Accident Risk 144 10.4 Conclusion 148 References 148 Appendix A: Synthesis of Forms of Financial Contracts 149 Appendix B: Definitions of Variables 150 Chapter 11 Venture Capital Risk with Optimal Financing Structure 153 11.1 Some Statistics about Venture Capital 154 11.2 Role of Venture Capital Firms 155 11.3 Venture Capital Firms and Added Value 156 11.4 Role of Convertible Debt 156 11.5 Information Asymmetry and Venture Capital 158 11.6 Conclusion 163 References 164 Chapter 12 Bank Credit Risk: Scoring of Individual Risks 167 12.1 Theoretical Model 169 12.2 Empirical Analysis 171 12.3 Credit Line and Loan Default 180 12.4 Conclusion 182 References 182 Chapter 13 Portfolio Management of Credit Risk 185 13.1 CreditMetrics 185 13.2 Review of Chapters 2 and 3 of CreditMetrics 186 13.3 KMV Approach 193 13.4 Calculation of Correlations 196 13.5 Conclusion 202 References 202 Chapter 14 Quantification of Banks' Operational Risk 205 14.1 Context and Presentation of Operational Risk 205 14.2 Measurement of Regulatory Capital 208 14.3 Calculation of Regulatory Capital for Losses of over $1 Million (LDA) 210 14.4 Conclusion 227 References 228 Chapter 15 Liquidity Risk 231 15.1 Theoretical Modeling of CDSs 232 15.2 Bond Yield Spread's Default Portion 233 15.3 Empirical Measurement of Yield Spreads' Default Portion 235 15.4 Non-Default Portion of Yield Spreads 237 15.5 Illiquidity Index 242 15.6 Illiquidity Premium 244 15.7 Data 244 15.8 Principal Component Analysis of Liquidity Risk 245 15.9 Empirical Analysis of Credit Cycles 246 15.10 Regime Detection Model 248 15.11 Detection of Default and Liquidity Regimes 250 15.12 Conclusion 251 References 252 Chapter 16 Long-Term Capital Management 255 16.1 Brief History of the Fund 256 16.2 Risk Management, VaR, and Required Capital 258 16.3 Portfolio Optimization and Leverage Effect 260 16.4 Conclusion 261 References 262 Chapter 17 Structured Finance and the Financial Crisis of 2007-2009 263 17.1 Structured Finance 263 17.2 Poor Risk Management Linked to the Structured Finance Market 264 17.3 Conclusion 266 References 268 Appendix: How to Create an AAA CDO Tranche from BBB Loans 269 Chapter 18 Risk Management and Corporate Governance 271 18.1 Enron and Corporate Governance 271 18.2 Financial Crisis and Corporate Governance 273 18.3 New 2002 Governance Rules 273 18.4 Risk Management and Governance 274 18.5 Administrative Competence of Board Members 276 18.6 New Regulation for Financial Institutions 276 18.7 Economic Analysis of Governance Effect 277 18.8 Conclusion 288 References 288 Appendix A: Governance of Canadian Federal Financial Institutions 290 Appendix B: Details on the Construction of the Governance Indexes 291 Appendix C: Variables 293 Chapter 19 Risk Management and Industrial Organization 295 19.1 Entry, Production, and Hedging 295 19.2 Commitment to Hedging 297 19.3 Conclusion 297 References 299 Chapter 20 Real Implications of Corporate Risk Management 301 20.1 Real Implications of Corporate Risk Management: A Review 302 20.2 Methodology 303 20.3 US Oil Producers 309 20.4 Multivariate Results 316 20.5 Conclusion 324 References 324 Appendix: Estimated MTEs 326 Chapter 21 Exercises 331 Exercise 1 Portfolio Choice and the Notion of Value at Risk (VaR) 331 Exercise 2 Backtesting of VaR Models 345 Exercise 3 Calculation of VaR with Different Distributions and Accuracy of VaR 351 Exercise 4 VaR for an Equity Portfolio with Options 359 Exercise 5 CVaR Conditional Value at Risk 369 Conclusion 376 Reference 376 Conclusion 377 General References 378 Index 379