Practical methods for measuring and managing operational risk in the financial sector: A clinical study

in Journal of Banking and Finance (2008), 32

This paper analyzes the implications of the Advanced Measurement Approach (AMA) for the assessment of operational risk. Through a clinical case study on a matrix of two selected business lines and two ... [more ▼]

This paper analyzes the implications of the Advanced Measurement Approach (AMA) for the assessment of operational risk. Through a clinical case study on a matrix of two selected business lines and two event types of a large financial institution, we develop a procedure that addresses the major issues faced by banks in the implementation of the AMA. For each cell, we calibrate two truncated distributions functions, one for “normal” losses and the other for the “extreme” losses. In addition, we propose a method to include external data in the framework. We then estimate the impact of operational risk management on bank profitability, through an adapted measure of RAROC. The results suggest that substantial savings can be achieved through active management techniques. [less ▲]

Linearizing Option Returns for Portfolio and Risk Management

Conference (2007, October 18)

This paper proposes a method to deduce the first four moments and the co-moments (with any other asset) of an option return. We consider the dynamics of an option-replicating portfolio of four basic ... [more ▼]

This paper proposes a method to deduce the first four moments and the co-moments (with any other asset) of an option return. We consider the dynamics of an option-replicating portfolio of four basic assets: the underlying, two long-term options and a zero coupon bond. This approach allows us to capture the moments up to order four of the underlying and to linearize the option return. A numerical example illustrates some of the features and applications of this model. [less ▲]

How Do Performance Measures Perform

in Journal of Portfolio Management (2007), 33(4), 64-74

The article presents a discussion on how various performance measures actually perform when used in investment portfolio management. The author discusses the empirical quality of performance measures such ... [more ▼]

The article presents a discussion on how various performance measures actually perform when used in investment portfolio management. The author discusses the empirical quality of performance measures such as information ratio (IR), focusing on directional managed portfolios, the Treynor ratio, and an empirical methodology that allows many of the usual errors associated with ratios to be avoided. The author also discusses multi-index models, style-based mutual funds, and style-adjusted performance. [less ▲]

Concentrated Announcements on Clustered Data: An Event Study on Biotechnology Stocks

in Financial Management (2006), 35(1), 129-157

In spring 2000, three events--two political statements by Bill Clinton and Tony Blair and a breakthrough announcement by Celera Genomics--had a major impact on biotechnology stocks. We analyze their ... [more ▼]

In spring 2000, three events--two political statements by Bill Clinton and Tony Blair and a breakthrough announcement by Celera Genomics--had a major impact on biotechnology stocks. We analyze their effects over a comprehensive set of biopharmaceutical companies, using a composite return-generating model with an industry-specific patent-based factor. Our results show that stocks can be clustered according to their responsiveness to political and scientific events. Furthermore, we emphasize different impacts on the market value of intangible assets for each cluster, suggesting that growth options are valued with different criteria for therapeutics, and technology-based subsectors. [less ▲]

The Generalized Treynor Ratio

in Review of Finance (2005), 9(3), 415-435

This paper extends the Treynor performance ratio for a single index to the case of multiple indexes. The new measure, called the Generalized Treynor Ratio, preserves the same key geometric and analytical ... [more ▼]

This paper extends the Treynor performance ratio for a single index to the case of multiple indexes. The new measure, called the Generalized Treynor Ratio, preserves the same key geometric and analytical properties of the original Treynor Ratio. The Generalized Treynor Ratio is defined as the abnormal return of a portfolio per unit of premium-weighted average systematic risk, normalized by the premium-weighted average systematic risk of the benchmark. Numerical simulations reveal that the portfolio rankings produced with this measure are more precise and more stable than the ones provided by Jensen's alpha and the Information Ratio. [less ▲]

Grafting Information in Scenario Trees: Application to Option Prices

E-print/Working paper (2005)

The high level of sophistication in portfolio management modeling techniques often goes along with very large output sensitivity to parameter choices. As a potential solution to this problem, this paper ... [more ▼]

The high level of sophistication in portfolio management modeling techniques often goes along with very large output sensitivity to parameter choices. As a potential solution to this problem, this paper proposes a consistent and flexible methodology to represent the distribution of future values of a portfolio through scenario trees. This methodology relies on the information contained in current option prices in order to generate the probability density function of future returns. This density function can be used, in turn, to generate scenario trees . As an illustration, a tree of scenarios based on S&P500 options is built and then used to compute arbitrage-free option prices. The approach preserves information embedded in options prices and is able to provide very accurate values for out-of-sample options. The high level of numerical accuracy of the framework is reproduced on different samples. The scenario tree approach also provides stable pricing results when confronted with the passage of time. The results derived from our model are comparable to those obtained from Rubinstein’s [1994] methodology, although both models fulfill different objectives. [less ▲]

Hedge Funds: Insights in Performance Measurement, Risk Analysis, and Portfolio Allocation

Book published by J. Wiley & sons (2005)

Credit derivatives with multiple debt issues

in Journal of Banking & Finance (2004), 28(5), 997-1021

We evaluate the most actively traded types of credit derivatives within a unified pricing framework that allows for multiple debt issues. Since firms default on all of their obligations, total debt is ... [more ▼]

We evaluate the most actively traded types of credit derivatives within a unified pricing framework that allows for multiple debt issues. Since firms default on all of their obligations, total debt is instrumental in the likelihood of default and therefore in credit derivatives valuation. We use a single factor interest rate model where the exponential default frontier is based on total debt and is made coherent with observed bond prices. Analytical formulae are derived for credit default swaps, total return swaps (both fixed-for-fixed and fixed-for-floating), and credit risk options (CROs). Price behaviors and hedging properties of all these credit derivatives are investigated. Simulations document that credit derivatives prices may be significantly affected by terms of debt other than those of the reference obligation. The analysis of CROs indicates their superior ability to fine-tune the hedging of magnitude and arrival risks of default. (C) 2003 Elsevier B.V. All rights reserved. [less ▲]

The credit risk components of a swap portfolio

in Journal of Futures Markets (2004), 24(1), 93-115

Thanks to the recent development of analytical pricing models for swaps with bilateral credit risk, a comprehensive analysis of the dimensions of default risk has become possible. Using the model ... [more ▼]

Thanks to the recent development of analytical pricing models for swaps with bilateral credit risk, a comprehensive analysis of the dimensions of default risk has become possible. Using the model developed by Hubner (2001) for IRS and CS, this article investigates the impact of structural and temporary credit risk changes on swap prices. It emphasizes that large variations in swap values and sensitivities may exist depending on the sources of credit risk differences between the counterparties. This phenomenon is stronger for CS because of the exchange of principal and an additional correlation risk that exhibits a nonnegligible impact on the contract value. The influence of a netting master agreement also can be analyzed for a wide range of initial contract values and netted notionals. The results confirm the hedging properties put forward by Duffie and Huang (1996) as a special case, but clearly show that they cannot be generalized to any netting pattern. Prevailing market conditions are shown to play a central role in the effectiveness of netting as a hedging device. (C) 2004 Wiley Periodicals, Inc. [less ▲]

Development path and capital structure of belgian biotechnology firms

in Butzen, Paul (Ed.) Firms' investment and finance decisions: Theory and empirical methodology (2003)