The Analytics of Risk Model Validation (Quantitative Finance)

217 Pages·2007·2 MB·English

by  George A. Christodoulakis

The Analytics of Risk Model Validation
Quantitative Finance Series
Aims and Objectives
•
booksbasedontheworkoffinancialmarketpractitioners,andacademics
•
presentingcuttingedgeresearchtotheprofessional/practitionermarket
•
combiningintellectualrigourandpracticalapplication
•
coveringtheinteractionbetweenmathematicaltheoryandfinancialpractice
•
toimproveportfolioperformance,riskmanagementandtradingbookperformance
•
coveringquantitativetechniques
Market
Brokers/Traders; Actuaries; Consultants; Asset Managers; Fund Managers; Regulators; Central
Bankers;TreasuryOfficials;TechnicalAnalysts;andAcademicsforMastersinFinanceandMBA
market.
SeriesTitles
Return Distributions in Finance
Derivative Instruments: Theory, Valuation, Analysis
Managing Downside Risk in Financial Markets
Economics for Financial Markets
Performance Measurement in Finance
Real R&D Options
Advanced Trading Rules, Second Edition
Advances in Portfolio Construction and Implementation
Computational Finance
Linear Factor Models in Finance
Initial Public Offerings
Funds of Hedge Funds
Venture Capital in Europe
Forecasting Volatility in the Financial Markets, Third Edition
International Mergers and Acquisitions Activity Since 1990
Corporate Governance and Regulatory Impact on Mergers and Acquisitions
Forecasting Expected Returns in the Financial Markets
The Analytics of Risk Model Validation
Series Editor
Dr Stephen Satchell
DrSatchellisaReaderinFinancialEconometricsatTrinityCollege,Cambridge;visitingProfessor
at Birkbeck College, City University Business School and University of Technology, Sydney. He
alsoworksinaconsultativecapacitytomanyfirms,andeditstheJournalofDerivativesandHedge
Funds,TheJournalofFinancialForecasting,JournalofRiskModelValidationandtheJournalof
AssetManagement.
The Analytics of Risk Model
Validation
Edited by
George Christodoulakis
Manchester Business School, University of Manchester, UK
Stephen Satchell
Trinity College, Cambridge, UK
AMSTERDAM•BOSTON•HEIDELBERG•LONDON•NEWYORK•OXFORD
PARIS•SANDIEGO•SANFRANCISCO•SINGAPORE•SYDNEY•TOKYO
AcademicPressisanimprintofElsevier
AcademicPressisanimprintofElsevier
30CorporateDrive,Suite400,Burlington,MA01803,USA
84Theobald’sRoad,LondonWC1X8RR,UK
525BStreet,Suite1900,SanDiego,CA92101-4495,USA
Firstedition2008
Copyright©2008ElsevierLtd.Allrightsreserved
Nopartofthispublicationmaybereproduced,storedinaretrievalsystem
ortransmittedinanyformorbyanymeanselectronic,mechanical,photocopying,
recordingorotherwisewithoutthepriorwrittenpermissionofthepublisher
PermissionsmaybesoughtdirectlyfromElsevier’sScience&TechnologyRights
DepartmentinOxford,UK:phone[phone];fax[phone];
email:[e-mail]tyourrequestonlineby
visitingtheElsevierwebsiteathttp://elsevier.com/locate/permissions,andselecting
ObtainingpermissiontouseElseviermaterial
Notice
Noresponsibilityisassumedbythepublisherforanyinjuryand/ordamagetopersons
orpropertyasamatterofproductsliability,negligenceorotherwise,orfromanyuse
oroperationofanymethods,products,instructionsorideascontainedinthematerial
herein.
BritishLibraryCataloguinginPublicationData
AcataloguerecordforthisbookisavailablefromtheBritishLibrary
LibraryofCongressCataloging-in-PublicationData
AcatalogrecordforthisbookisavailablefromtheLibraryofCongress
ISBN:978-0-7506-8158-2
ForinformationonallAcademicPresspublications
visitourwebsiteatbooks.elsevier.com
PrintedandboundinGreatBritain
08 09 10 11 10 9 8 7 6 5 4 3 2 1
Working together to grow
libraries in developing countries
www.elsevier.com | www.bookaid.org | www.sabre.org
Contents
About the editors vii
About the contributors ix
Preface xiii
1 Determinants of small business default 1
Sumit Agarwal, Souphala Chomsisengphet and Chunlin Liu
2 Validation of stress testing models 13
Joseph L. Breeden
3 The validity of credit risk model validation methods 27
George Christodoulakis and Stephen Satchell
4 A moments-based procedure for evaluating risk forecasting models 45
Kevin Dowd
5 Measuring concentration risk in credit portfolios 59
Klaus Duellmann
6 A simple method for regulators to cross-check operational risk loss
models for banks 79
Wayne Holland and ManMohan S. Sodhi
7 Of the credibility of mapping and benchmarking credit risk estimates for
internal rating systems 91
Vichett Oung
8 Analytic models of the ROC curve: Applications to credit rating
model validation 113
Stephen Satchell and Wei Xia
9 The validation of the equity portfolio risk models 135
Stephen Satchell
10 Dynamic risk analysis and risk model evaluation 149
Günter Schwarz and Christoph Kessler
11 Validation of internal rating systems and PD estimates 169
Dirk Tasche
Index 197
This page intentionally left blank
About the editors
Dr George Christodoulakis is an expert in quantitative finance, focusing on financial
theory and the econometrics of credit and market risk. His research work has been
published in international refereed journals such as Econometric Reviews, the European
Journal of Operational Research and the Annals of Finance and he is a frequent speaker
atinternationalconferences.DrChristodoulakishasbeenamemberofthefacultyatCass
Business School City University and the University of Exeter, an Advisor to the Bank of
Greece and is now appointed at Manchester Business School, University of Manchester.
He holds two masters degrees and a doctorate from the University of London.
Dr Stephen Satchell is a Fellow of Trinity College, Reader in Financial Econometrics at
theUniversityofCambridgeandVisitingProfessoratBirkbeckCollege,CityUniversityof
Technology,atSydney,Australia.Heprovidesconsultancyforarangeofcityinstitutions
in the broad area of quantitative finance. He has published papers in many journals and
has a particular interest for risk.
This page intentionally left blank
About the contributors
SumitAgarwalisafinancialeconomistintheresearchdepartmentattheFederalReserve
Bank of Chicago. His research interests include issues relating to household finance, as
wellascorporatefinance,financialinstitutionsandcapitalmarkets.Hisresearchhasbeen
publishedinsuchacademicjournalsastheJournalofMoney,CreditandBanking,Journal
of Financial Intermediation, Journal of Housing Economics and Real Estate Economics.
He has also edited a book titled Household Credit Usage: Personal Debt and Mortgages
(with Ambrose, B.).
Prior to joining the Chicago Fed in July 2006, Agarwal was Senior Vice President
and Credit Risk Management Executive in the Small Business Risk Solutions Group of
Bank of America. He also served as an Adjunct Professor in the finance department
at the George Washington University. Agarwal received a PhD from the University of
Wisconsin-Milwaukee.
Joseph L. Breeden earned a PhD in physics in 1991 from the University of Illinois. His
thesis work involved real-world applications of chaos theory and genetic algorithms. In
the mid-1990s, he was a member of the Santa Fe Institute.
DrBreedenhasspentthepast12yearsdesigninganddeployingforecastingsystemsfor
retail loan portfolios. At Strategic Analytics, which he co-founded in 1999, Dr Breeden
leads the design of advanced analytic solutions including the invention of Dual-time
Dynamics. Dr Breeden has worked on portfolio forecasting, stress testing, economic
capital and optimization in the US, Europe, South America and Southeast Asia both,
during normal conditions and economic crises.
Souphala Chomsisengphet is Senior Financial Economist in the Risk Analysis Division
at the Office of the Comptroller of the Currency (OCC), where she is responsible for
evaluatingnationalcharteredbanks’developmentandvalidationofcreditriskmodelsfor
underwriting, pricing, risk management and capital allocation. In addition, she conducts
empiricalresearchonconsumerbehavioralfinance,financialinstitutionsandriskmanage-
ment.HerrecentpublicationsincludearticlesintheJournalofUrbanEconomics,Journal
ofHousingEconomics,JournalofFinancialIntermediation,RealEstateEconomics,and
Journal of Credit Risk.
Prior to joining the OCC, Chomsisengphet was an economist in the Office of Policy
Analysis and Research at the Office of Federal Housing Enterprise Oversight (OFHEO).
She earned a PhD in Economics from the University of Wisconsin-Milwaukee.
KevinDowdiscurrentlyProfessorofFinancialRiskManagementatNottinghamUniver-
sity Business School, where he works in the Centre for Risk and Insurance Studies. His
research interests are in financial, macro and monetary economics, political economy,