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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