Peking University HSBC Business School
Timothy (Jun) Lu
Spring 2012
(Draft, subject to change)
This course is designed to apply the theories and methodologies to the complex needs of managing financial risk in financial institutions. With the development of the financial market and the current financial crisis, it is extremely important for today’s financial professionals to understand the types of financial risks that they are facing. This course will introduce several risk management models to measure and manage various types of risks, including equity risk, interest-rate risk, and credit risk. We develop and critique theoretical models for each type of risk, while emphasis is strongly placed on the implementation of the models. Furthermore, we relate this course to the ongoing financial crisis by discussing the measurements and the attempts to regulate systemic risk.
This course is intended for students who consider a career in the finance industry. This is a highly quantitative course, and students are required to have basic knowledge of finance, statistics, and working knowledge of Excel.
Upon completion of this course, students will be able to:
- Summarize the equity risk exposure using simulation and various measures of risk including Value-of-Risk
- Test the accuracy of risk models, including GARCH model
- Understand dependence measures (copulas) beyond linear correlation and its importance for portfolio risk
- Provide a detailed description of default-free term structure models and the issues involved in their implementation and calibration
- Provide a detailed description of defaultable bond models and their implementation and calibration
- Compute estimates for the parameters of default-free and defaultable term structure models given an appropriate set of data observations
- Provide a detailed description of the meaning and interpretation of the output from these models using the terminology and concepts of risk management
- Make and evaluate recommendations related to a firm’s equity, interest rate, and credit risk management programs
- Understand the concept and measures of systemic risk, including bank runs and currency crisis
- Make and evaluate recommendations related to regulations for systemic risk reduction purpose
Grading of this course will be based on a final exam, a mid-term exam, and group project(s).
Textbook (Tentative)
John C. Hull, Risk Management and Financial Institutions: International Edition, 2/E, Pearson Higher Education, 2009
Other course notes and readings.
Tentative Syllabus
Equity Risk Management
- Risk model for asset and portfolio returns, sample estimates, normally distributed returns
- Risk measures, including VaR and expected shortfall
- Time-dependent volatility models, including GARCH, parameter estimation through Maximum Likelihood Method
- Testing normally distributed returns and autocorrelation
- Testing normally versus non-normally distributed returns through Maximum Likelihood Ratio Test
- Extreme Value Theory
- No-arbitrage valuation, risk-neutral probability distribution
- Implementation of Binomial lattice model
- Copula
- Monte Carlo simulation, bootstrapping, and Cholesky factorization
Interest-rate Risk Management
- Overview of fixed income securities
- Term-structure models, no-arbitrage and restrictions on term-structure dynamics
- Implementation and calibration of term-structure models, Ho-Lee model for short-rate
- Heath-Jarrow-Morton (HJM) model for forward rates
- Calibration of the HJM model
- Multi-factor and continuous-time HJM model, Monte Carlo simulation based on HJM model
Credit Risk Management
- Overview of credit risk
- Structural and reduced-form models, Merton’s structural model and its KMV application
- Jarrow-Turnbull reduced form model of default risk
- Jarrow-Lando-Turnbull reduced form model of credit migration
- Implementation of reduced-form models
- Valuation of cash flows subject to default risk
Systemic Risk
- Overview of systemic risk
- Diamond-Dybvig model, and Goldstein-Pauzner model of bank runs
- Morris-Shin model of currency crisis
- Measures of systemic risk, including Too Big to Fail and Too Interconnected to Fail, Allen-Gale model of inter-bank connections
- The pros and cons of regulations to reduce systemic risk
