Risk Management: Foundations For a Changing Financial World

Foreword xiii

Acknowledgments xv

Introduction 1

PART I OVERVIEW—TWO DECADES OF RISK MANAGEMENT 5
1990–1999

CHAPTER 1 A Framework for Understanding Market Crisis 7
Richard M. Bookstaber
Reprinted from AIMR Conference Proceedings: Risk Management: Principles and Practices (August 1999):7–19.

CHAPTER 2 Practical Issues in Choosing and Applying Risk Management Tools 25
Jacques Longerstaey
Reprinted from AIMR Conference Proceedings: Risk Management: Principles and Practices (August 1999):52–61.

CHAPTER 3 The Three P’s of Total Risk Management 39
Andrew W. Lo
Reprinted from the Financial Analysts Journal (January/February 1999):13–26.

CHAPTER 4 Reporting and Monitoring Risk Exposure 61
Robert W. Kopprasch, CFA
Reprinted from AIMR Conference Proceedings: Risk Management (April 1996): 25–33.

2000–Present

CHAPTER 5 Risk Management: A Review 73
Sébastien Lleo, CFA
Modified from The Research Foundation of CFA Institute (February 2009).

CHAPTER 6 Defining Risk 113
Glyn A. Holton
Reprinted from the Financial Analysts Journal (November/December 2004): 19–25.

CHAPTER 7 Value and Risk: Beyond Betas 125
Aswath Damodaran
Reprinted from the Financial Analysts Journal (March/April 2005):38–43.

CHAPTER 8 A Simple Theory of the Financial Crisis; or, Why Fischer Black Still Matters 133
Tyler Cowen
Reprinted from the Financial Analysts Journal (May/June 2009):17–20.

CHAPTER 9 Managing Firm Risk 139
Bluford H. Putnam
Reprinted from AIMR Conference Proceedings: Ethical Issues for Today’s Firm (July 2000):51–61.

CHAPTER 10 Risk Measurement versus Risk Management 153
D. Sykes Wilford
Reprinted from AIMR Conference Proceedings: Improving the Investment Process through Risk Management (November 2003):17–21.

PART II: MEASURING RISK 161

CHAPTER 11 What Volatility Tells Us about Diversification and Risk Management 163
Max Darnell
Reprinted from CFA institute conference proceedings quarterly (september 2009):57–66.

CHAPTER 12 Risk²: Measuring the Risk in Value at Risk 175
Philippe Jorion
Reprinted from the Financial Analysts Journal (November/December 1996): 47–56.

CHAPTER 13 How Risk Management can Benefit Portfolio Managers 189
Michelle McCarthy
Reprinted from AIMR Conference Proceedings: Risk Management: Principles and Practices (August  1999):62–72.

CHAPTER 14 Merging the Risk Management Objectives of the Client and Investment Manager 205
Bennett W. Golub
Reprinted from AIMR Conference Proceedings: Exploring the Dimensions of Fixed-Income Management (March 2004):13–23.

CHAPTER 15 The Mismeasurement of Risk 219
Mark Kritzman, CFA, and Don Rich
Reprinted from the Financial Analysts Journal (May/June 2002):91–99.

CHAPTER 16: Riskiness in Risk Measurement 233
Roland Lochoff
Reprinted from AIMR Conference Proceedings: Exploring the Dimensions of Fixed-Income Management (March 2004):40–51.

CHAPTER 17 The Second Moment 249
Don Ezra
Reprinted from the Financial Analysts Journal (January/February 2009): 34–36.

CHAPTER 18 The Sense and Nonsense of Risk Budgeting 253
Arjan B. Berkelaar, CFA, Adam Kobor, CFA, and Masaki Tsumagari, CFA
Reprinted from the Financial Analysts Journal (September/October 2006): 63–75.

CHAPTER 19 Understanding and Monitoring the Liquidity Crisis Cycle 273
Richard Bookstaber
Reprinted from the Financial Analysts Journal (September/October 2000):17–22.

CHAPTER 20 Why Company-Specifi c Risk Changes over Time 283
James A. Bennett, CFA, and Richard W. Sias
Reprinted from the Financial Analysts Journal (September/October 2006): 89–100.

CHAPTER 21 Black Monday and Black Swans 301
John C. Bogle
Reprinted from the Financial Analysts Journal (March/April 2008):30–40.

CHAPTER 22 The Uncorrelated Return Myth 317
Richard M. Ennis, CFA
Reprinted from the Financial Analysts Journal (November/December 2009):6–7.

PART III: MANAGING RISK 321

Alternative Investments

CHAPTER 23 Risk Management for Hedge Funds: Introduction and Overview 323
Andrew W. Lo
Reprinted from the Financial Analysts Journal (November/December 2001): 16–33.

CHAPTER 24 Risk Management for Alternative Investment Strategies 353
Leslie Rahl
Reprinted from AIMR Conference Proceedings: Exploring the Dimensions of Fixed-Income Management (March 2004):52–62.

CHAPTER 25 Sources of Change and Risk for Hedge Funds 367
Clifford S. Asness
Reprinted from CFA Institute Conference Proceedings: Challenges and Innovation in Hedge Fund Management (August 2004):4–9, 13–14.

CHAPTER 26 Risk Management in a Fund of Funds 379
S. Luke Ellis
Reprinted from CFA Institute Conference Proceedings: Challenges and Innovation in Hedge Fund Management (August 2004):31–39.

CHAPTER 27 Hedge Funds: Risk and Return 391
Burton G. Malkiel and Atanu Saha
Reprinted from the Financial Analysts Journal (November/December 2005): 80–88.

Credit Risk

CHAPTER 28 Credit Risk 407
Jeremy Graveline and Michael Kokalari
Modified from The Research Foundation of CFA Institute (November 2006).

CHAPTER 29 Tumbling Tower of Babel: Subprime Securitization and the Credit Crisis 427
Bruce I. Jacobs
Reprinted from the Financial Analysts Journal (March/April 2009):17–30.

CHAPTER 30 Applying Modern Risk Management to Equity and Credit Analysis 447
Robert C. Merton
Reprinted from CFA Institute Conference Proceedings Quarterly (December 2007):14–22.

Derivatives

CHAPTER 31 The Uses and Risks of Derivatives 459
Joanne M. Hill
Reprinted from AIMR Conference Proceedings: Investing Worldwide VI (January 1996):46–58.

CHAPTER 32 Effective Risk Management in the Investment Firm 475
Mark C. Brickell
Reprinted from AIMR Conference Proceedings: Risk Management (April 1996):48–55.

CHAPTER 33 Risk-Management Programs 487
Maarten Nederlof
Reprinted from AIMR Conference Proceedings: Risk Management (April 1996):15–24.

CHAPTER 34 Does Risk Management Add Value? 501
Charles W. Smithson
Reprinted from AIMR Conference Proceedings: Corporate Financial Decision Making and Equity Analysis (July 1995):47–53.

CHAPTER 35 Risk Management and Fiduciary Duties 511
Robert M. McLaughlin
Reprinted from AIMR Conference Proceedings: Risk Management: Principles and Practices (August 1999):20–31.

Global Risk

CHAPTER 36 Financial Risk Management in Global Portfolios 529
R. Charles Tschampion, CFA
Reprinted from AIMR Conference Proceedings: Investing Worldwide VI (January 1996):67–73.

CHAPTER 37 Universal Hedging: Optimizing Currency Risk and Reward in International Equity Portfolios 539
Fischer Black
Reprinted from the Financial Analysts Journal (July/August 1989):16–22.

CHAPTER 38 Strategies for Hedging 551
Mark P. Kritzman, CFA
Reprinted from AIMR Conference Proceedings: Managing Currency Risk (November 1997):28–38.

CHAPTER 39 Currency Risk Management in Emerging Markets 567
H. Gifford Fong
Reprinted from AIMR Conference Proceedings: Investing Worldwide VII (September 1996):18–23.

CHAPTER 40 Managing Geopolitical Risks 573
Marvin Zonis
Reprinted from CFA Institute Conference Proceedings Quarterly (September 2009):22–29.

CHAPTER 41 Country Risk in Global Financial Management 583
Claude B. Erb, CFA, Campbell R. Harvey, and Tadas E. Viskanta
Reprinted from the Research Foundation of CFA Institute (January 1998).

CHAPTER 42 Political Risk in the World Economies 651
Marvin Zonis
Reprinted from AIMR Conference Proceedings: Investing Worldwide VIII: Developments in Global Portfolio Management (September 1997):1–6.

Nonfinancial Risk

CHAPTER 43 A Behavioral Perspective on Risk Management 657
Andrew W. Lo
Reprinted from AIMR Conference Proceedings: Risk Management: Principles and Practices (August 1999):32–37.

CHAPTER 44 Behavioral Risk: Anecdotes and Disturbing Evidence 667
Arnold S. Wood
Reprinted from AIMR Conference Proceedings: Investing Worldwide VI (January 1996):74–78.

CHAPTER 45 The Ten Commandments of Operational Due Diligence 673
Robert P. Swan III
Reprinted from CFA Institute Conference Proceedings: Challenges and Innovation in Hedge Fund Management (August 2004):47–52.

CHAPTER 46 Models 681
Emanuel Derman
Reprinted from the Financial Analysts Journal (January/February 2009):28–33.

CHAPTER 47 The Use and Misuse of Models in Investment Management 689
Douglas T. Breeden
Reprinted from CFA Institute Conference Proceedings Quarterly (December 2009): 36–45.

CHAPTER 48 Regulating Financial Markets: Protecting Us from Ourselves and Others 701
Meir Statman
Reprinted from the Financial Analysts Journal (May/June 2009):22–31.

Pension Risk

CHAPTER 49 Budgeting and Monitoring Pension Fund Risk 715
William F. Sharpe
Reprinted from the Financial Analysts Journal (September/October 2002):74–86.

CHAPTER 50 The Plan Sponsor’s Perspective on Risk Management Programs 735
Desmond Mac Intyre
Reprinted from AIMR Conference Proceedings: Risk Management: Principles and Practices (August 1999):38–44.

CHAPTER 51 Evaluating a Risk-Management Program 745
Christopher J. Campisano, CFA
Reprinted from AIMR Conference Proceedings: Risk Management (April 1996):41–47.

CHAPTER 52 Developing and Implementing a Risk-Budgeting System 755
Leo J. de Bever
Reprinted from AIMR Conference Proceedings: Improving the Investment Process through Risk Management (November 2003):62–72.

CHAPTER 53 Liability-Driven Investment Strategies for Pension Funds 771
Roman von Ah
Reprinted from CFA Institute Conference Proceedings Quarterly (December 2008):39–46.

About the Contributors 781

Index 783