Steve Allen & Ken Abbott

 

Office Hours for Steve Allen:
Office Hours: Monday 4–5 PM or by appointment. Students are encouraged to speak with me about the course as well as financial mathematics and risk management in general.


Spring 2006

Course:      G63.2753 Risk Management
                 Tuesdays 7:10 - 9:00, Room 1302 Warren Weaver Hall

Text:   Allen, Steven. 2003. Financial Risk Management: A Practitioner's Guide to Managing Market and Credit Risk. Hoboken, NJ: John Wiley & Sons, Inc.

Note: This book is available at the NYU Bookstore or can be ordered through Amazon.com

 

Week 1.  Jan. 17 Introduction to Risk Management

The importance of risk management for financial firms and the key role played by financial mathematics.  The difference between risk management at the trading desk level and at the firm level and the relationship between them.  The relationship between insiders and outsiders in managing risk and the role of moral hazard.  The two tracks of the course:  macro risk management and micro risk management and the relationship between them (Allen).

 

The principles of risk management, its mission and mandate.  The skill set required.  Interaction with other functions.  The required infrastructure for risk management The historical evolution of risk management (Abbott).

 

Reading:  Allen, Chapter 1

 

 

 

Macro Risk Management (Abbott)

 

Weeks 2 & 3  Jan. 24 & Jan. 31

 

Value-at-Risk and stress testing methodology.  Measurement using exploratory data analysis, variance-covariance, historical simulation, Monte Carlo simulation, economic scenarios, extreme value theory.

 

Reading:  Allen, Chapter 11, Lecture notes

 

Week 4.  Feb. 7 Credit risk methodology.  The Merton model, KMV, copula techniques, measurement of counterparty exposure.

 

Reading:  Allen, Chapter 12, Lecture notes

 

Weeks 5 & 6 Feb 14 & Feb. 21.  Regulation and capital.  Basle standards, calculation of economic capital, operational risk, practical elements of model validation, problems with risk management.

 

Reading:  Allen, Chapters 3 & 6.  Lecture notes

 

Micro Risk Management (Allen)

 

Week 7.  Feb. 28 Risk Management Framework.

Different approaches to controlling risk — incentives vs. regulations.  Ponzi schemes, adverse selection, and the winner’s curse.  The nature of risk limits — purpose, setting, and monitoring.

 

Reading:  Allen, Chapters 2, 5 and 7.

 

Week 8.  Mar. 7 Interest rate risk measurement.  Design of bucketed and principle component sensitivity reports to explain income and control risk.

 

Reading:  Allen, Chapter 8.

 

Week 9.  Mar. 21 Vanilla option risk.  Use of the Black-Scholes model in hedging options risk.  Monte Carlo simulation of hedging securities.

 

Reading:  Allen, Sections 9.1-9.3, 9.5

Supplemental Reading:  Taleb, Dynamic Hedging, Chapter 16 and pages 110-113

 

Week 10.  Mar. 28 Vanilla options risk reporting.  The use of price-volatility matrices and volatility surface sensitivities to explain income and control risk.  Extension to quasi-vanilla options.

 

Reading:  Allen, Sections 9.4, 9.6,10.1

 

Week 11.  Apr. 3 Static and dynamic hedging of exotic options and long-dated interest rate and vanilla options products.  Focus on stack-and-roll techniques for long-dated interest rates and vanilla options and on barrier options.  The sources of and control of model risk.

 

Reading:  Allen, Sections 8.2.2, 9.6.3, 10.2, 10.3

 

Week 12.  Apr. 10  Correlation risk.  Management of correlation risk for equity baskets, quantos, mortgage-backed securities, convertible bonds, credit default obligations, Bermudean swaptions.

 

Reading: Allen, Sections 10.4, 10.5

 

Week 13. Apr. 17 Risk management of asset managers and hedge funds.

Guest lecturer: Barry Schachter

 

Reading: Articles by Cliff Asness

 

Week 14.  Apr. 25 Financial disasters.  Study of historical incidents of financial failure due to breakdowns of risk management control and lessons to be learned

 

Reading:  Allen, Chapter 4.