Index
A
AAA rating, 71
Accounting betas, 218–219
Advanced measurement approach, for
operational risk
case study of, 131–134
description of, 12, 117–118
Agency ratings
cumulative default probability, 73
description of, 70–71, 112
external rating assignment, 71
information obtained from, 70
marginal default probabilities, 73
transition matrixes, 71–73
Allocated capital, 199–202, 215
Asset allocation, 5
Asset returns, 99
B
Back-testing
actual vs. theoretical portfolio
returns, 59–61
description of, 59, 65
Bank capitalization
description of, 7–8
optimal level of, 8
Bank loan recovery rates, 90–91
Bankers Trust, 172, 214
Basel Committee, 123
Basel I Accord
amendment to, 9
description of, 1, 8–9
regulatory capital as defi ned by, 9
Basel II Accord
asset classes, 82
competitive impact of, 16
debate about, 16–17
description of, 9
implementation of, 16–17
information resources, 113–114
internal ratings, 83
international accounting standards
and, 93–96
market discipline, 15
minimum capital requirements,
11–14
minimum regulatory capital
requirements affected by,
12–14, 22, 62
operational risk and, 116–118, 142
overview of, 10–17
pillars of, 10–17
summary of, 112
supervisory review process, 14–15
Basic indicator approach, for
operational risk, 12, 116
BBB rating, 72, 74
Benchmark capital, 135–136
Betas
accounting, 218–219
bottom-up, 218–219, 224
determination of, 224–225
historical, 218
Black–Scholes–Merton formula, 51,
75
Book capital at risk
business risk measurement and,
135–136
destruction of, 140
earnings at risk and, 140
market capitalization at risk vs.,
130, 220
minimum regulatory capital
requirements aligned with,
21
Book value of capital
defi nition of, 7, 17, 23
description of, 17–19
Book-value accounting, 67–68
Bottom-up betas, 218–219, 224
Budgeting process, 227–230, 231–232
Bureaucracies, 213
Business risk
cost of equity capital and, 223
defi nition of, 115, 134, 142, 210
information resources, 143
profi t volatility and, 134
relevance of, 135
summary of, 143
Business risk measurement
importance of, 134–136
measures used in
internal earnings data, 136
value-at-risk, 135
Business units
description of, 149
performance targets for, 217
target returns for, 22–227
C
Capital
allocated, 199–202, 215
alternative notions of, 20–21
diversifi ed, 202–207, 216
economic. See Economic capital
functions of, 2
importance of, 1
market value of, 17
minimum requirements, 11–14
profi tability below the cost of, 208
regulatory. See Regulatory capital
risk and, 2
target rate of return for. See Target
rate of return
undiversifi ed, 202–207, 216
utilized, 199–202, 215
value at risk measures and, 148
Capital allocation
asset allocation and, 5
capital investment vs., 199
case study of, 230–233
256 INDEX
decision-making processes
associated with, 4
defi nition of, 4
description of, 217, 227–228
focus of, 21
information resources, 234–235
as negotiation process, 201
opposite, 201
planning process and, 227–230,
231–232, 234
risk-adjusted performance measures
and, 234
summary of, 233–234
Capital at risk
allocation of, 170, 201
book. See Book capital at risk
business units, 149
defi nition of, 69, 195
diversifi ed, 164
earnings at risk measure used as
estimate for, 139–142
hybrid, 151
incremental, 203
market capitalization at risk vs.,
20
risk types, 149
Capital at risk measures
allocated capital, 199–202, 215
diversifi ed capital, 202–207, 216
summary of, 215
undiversifi ed capital, 202–207, 216
utilized capital, 199–202, 215
Capital investment, 199
Capital management
defi nition of, 4
focus of, 20
risk aggregation effects on, 145–146
Capital ratios, 1
Capital reallocation
description of, 5, 170, 217
planning process and, 227–228
Capital Requirement Directive, 16
CCC, 100
Clans, 213
Component value at risk, 186–188,
193–194
Conditional variance estimations, 42
Confi dence interval, 147–148
Confi dence level, 25
Cooke ratio, 8–9
Copulas, 56–57, 151, 165t
Core capital, 9
Correlation
estimation of, 39–42
implied, 44
Cost attribution, 198
Cost of equity capital
business risk and, 223
calculation methods, 234
description of, 218–219
Credit portfolio models
characteristics of, 96–97
classifi cation of, 96
comparison of, 108–110
CreditMetrics, 97–102, 109t
CreditPortfolioView, 102–105, 108,
109t
CreditRisk+, 105–108, 109t
industry practices, 110–111
PortfolioManager, 101–102, 109t
results obtained using, 111
summary of, 109t
Credit risk
agency ratings. See Agency ratings
defi ning of, 67–70
expected losses, 67–70
information resources, 113–114
minimum regulatory capital
requirements
foundation internal rating-based
approach, 80, 82
internal rating-based approach,
80, 82
overview of, 80–81
pricing limits for, 189–193
risk management for, 189
summary of, 112–113
transfer prices and, 197–198
unexpected losses, 67–70
value at risk, 147
Credit risk evaluations
credit-scoring systems, 78–80
Merton’s model, 74–78
Moody’s/KMV expected default
frequency, 74–78
Credit risk management, 68
Credit Suisse, 176
CreditMetrics, 97–102, 109t
CreditPortfolioView, 102–105, 108, 109t
CreditRisk+, 105–108, 109t
Credit-scoring systems, 78–80
Cumulative default probability, 73
Cumulative default rate, 73
Cumulative losses, 178–179
Cumulative mortality rate, 73
D
Daily value at risk
equivalent ex post yearly value at
risk from, 174–177
yearly ex ante acceptable loss
translated into, 177–178
Decay factor, 40
Default
defi nition of, 88, 94
loss given. See Loss given default
probability of. See Probability of
default
Delta, 34
Delta-gamma approximation, 53
Delta-gamma-vega approximation, 54
Derivatives accounting, 18–19
Deutsche Bank, 172, 176, 214
Disclosures, 15
Diversifi ed capital, 202–207, 216
Diversifi ed value at risk, 184, 186
“Downturn” loss given default, 90
E
Earnings at risk
book capital at risk and, 140
capital at risk estimates from,
139–142
description of, 135
economic capital for business risk
and, 137–139
losses and, 137
market capitalization at risk and, 141
measurement of, 137–139
Earnings cross-autocorrelation, 156
Earnings serial cross-autocorrelation,
156
Earnings volatility, 137–139
“Echo effect,” 39
Economic capital
calculation of, 17–18, 163
capital adequacy determinations
based on, 22–23
defi nition of, 7, 17
earnings at risk measures and,
137–139
integrated measures of, 146
measurement of, 18, 22
performance decisions based on,
21–22
regulatory capital vs., 17
return on, 21
Economic value added. See EVA
Equity capital, cost of, 218–219
Equity exposures, 32
Equity trading, 196
EVA, 195, 207–208
Expected default frequency, 74–78
Expected loss given default, 68, 90–91
Expected losses
analysis of, 96
defi nition of, 112
description of, 67–70, 95
Monte Carlo simulation for
estimating, 130
Expected shortfall, 57–59, 210
Exponentially weighted moving
averages, 40–42, 48
Exposure at default
defi nition of, 11, 92
estimation of, 92–93
summary of, 112
Exposure risk, 69
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