Acknowledgements     xi
Notes on the Contributors     xii
Introduction     xxi
Impact of the Collection Threshold on the Determination of the Capital Charge for Operational Risk   Yves Crama   Georges Hubner   Jean-Philippe Peters     1
Introduction     1
Measuring operational risk     3
The collection threshold     8
Empirical analysis     11
Conclusion     16
Incorporating Diversification into Risk Management   Amiyatosh Purnanandam   Mitch Warachka   Yonggan Zhao   William T. Ziemba     22
Introduction     22
Risk measure with diversification     24
Numerical example     31
Implementation     33
Pricing portfolio insurance     37
Conclusion     43
Sensitivity Analysis of Portfolio Volatility: Importance of Weights, Sectors and Impact of Trading Strategies   Emanuele Borgonovo   Marco Percoco     47
Introduction     47
Sensitivity analysis background     50
Effect of relative weight changes     51
Importance of portfolio weights in GARCH volatility estimation models     53
Empirical results: trading strategies through sensitivity analysis     56
Conclusion     64
Managing Interest Rate Risk under Non-Parallel Changes: An Application of a Two-Factor Model   Manuel Moreno     69
Introduction     69
The model     70
Generalized duration and convexity     72
Hedging ratios     74
A proposal of a solution for the limitations of the conventional duration     75
Conclusion     83
An Essay on Stochastic Volatility and the Yield Curve   Raymond Theoret   Pierre Rostan   Abdeljalil El-Moussadek     86
Introduction     86
Variations on stochastic volatility and conditional volatility     88
Interest rate term structure forecasting     92
Interest rate term structure models     92
Methodology     94
Data and calibration of the Fong and Vasicek model     97
Simulation     98
Empirical results     99
Conclusion     102
Idiosyncratic Risk, Systematic Risk and Stochastic Volatility: An Implementation of Merton's Credit Risk Valuation   Hayette Gatfaoui     107
Introduction     107
The general model      110
A stochastic volatility model     114
Simulation study     118
Conclusion     126
A Comparative Analysis of Dependence Levels in Intensity-Based and Merton-Style Credit Risk Models   Jean-David Fermanian   Mohammed Sbai     132
Introduction     132
Merton-Style models     133
Intensity-based models     136
Comparisons between some dependence indicators     139
Extensions of the basic intensity-based model     143
Conclusion     150
The Modeling of Weather Derivative Portfolio Risk   Stephen Jewson     156
Introduction     156
What are weather derivatives?     157
Defining risk for weather derivative portfolios     159
Basic methods for estimating the risk in weather derivative portfolios     160
The incorporation of sampling error in simulations     162
Accurate estimation of the correlation matrix     162
Dealing with non-normality     163
Estimating model error     164
Incorporating hedging constraints     165
Consistency between the valuation of single contracts and portfolios     166
Estimating sampling error     167
Estimating VaR      167
Conclusion     168
Optimal Investment with Inflation-Linked Products   Taras Beletski   Rolf Korn     170
Introduction     170
Modeling the evolution of an inflation index     171
Optimal portfolios with inflation linked products     173
Hedging with inflation linked products     182
Conclusion     189
Model Risk and Financial Derivatives   Francois-Serge Lhabitant     191
Introduction     191
From mathematical theory to financial practise     194
An illustration of model risk     195
The role of models for derivatives     197
The model-building process and model risk-creation     199
What if the model is wrong? a case study     201
Eleven rules for managing model risk     203
Conclusion     210
Evaluating Value-at-Risk Estimates: A Cross-Section Approach   Raffaele Zenti   Massimiliano Pallotta   Claudio Marsala     213
Introduction     213
Value-at-risk     214
Review of existing methods for backtesting     214
An extension: the cross-section approach     217
Applications      219
Conclusion     224
Correlation Breakdowns in Asset Management   Riccardo Bramante   Giampaolo Gabbi     226
Introduction     226
Data and descriptive statistics     226
Correlation jumps and volatility behavior     228
Impact on portfolio optimization     237
Conclusion     237
Sequential Procedures for Monitoring Covariances of Asset Returns   Olha Bodnar     241
Introduction     241
Covariance structure of asset returns and optimal portfolio weights     243
Multivariate statistical surveillance     246
Simultaneous statistical surveillance     251
A comparison of the multivariate and simultaneous control charts     253
Conclusion     258
An Empirical Study of Time-Varying Return Correlations and the Efficient Set of Portfolios   Thadavillil Jithendranathan     265
Introduction     265
Empirical Methodology and Data     267
Results     270
Conclusion     276
The Derivation of the NPV Probability Distribution of Risky Investments with Autoregressive Cash Flows   Jean-Paul Paquin   Annick Lambert   Alain Charbonneau      278
Introduction     278
Systematic risk and the perfect economy     280
Total risk and the real economy     282
The NPV probability distribution and the CLT: theoretical results     285
The NPV probability distribution and the CLT: simulation models and statistical tests     288
The NPV probability distribution and the CLT: simulation results     289
Conclusion     293
Have Volatility Transmission Patterns between the USA and Spain Changed after September 11?   Helena Chulia   Francisco J. Climent   Pilar Soriano   Hipolit Torro     303
Introduction     303
Data     305
The econometric approach     309
Empirical results     312
Conclusion     321
Large and Small Cap Stocks in Europe: Covariance Asymmetry, Volatility Spillovers and Beta Estimates   Helena Chulia   Hipolit Torro     327
Introduction     327
The econometric framework     329
Data and preliminary analysis     331
Results     335
Asymmetries analysis     342
Volatility spillovers     345
Conclusion     348
On Model Selection and its Impact on the Hedging of Financial Derivatives   Giuseppe Di Graziano   Stefano Galluccio     353
Introduction     353
Model and Mathematical setup     355
Analytical expression of the total hedging error     357
Numerical results     359
Conclusion     363
Index     365