Hedging Market Exposures: Identifying and Managing Market Risks

Identify and understand the risks facing your portfolio, how to quantify them, and the best tools to hedge them

This book scrutinizes the various risks confronting a portfolio, equips the reader with the tools necessary to identify and understand these risks, and discusses the best ways to hedge them.

The book does not require a specialized mathematical foundation, and so will appeal to both the generalist and specialist alike. For the generalist, who may not have a deep knowledge of mathematics, the book illustrates, through the copious use of examples, how to identify risks that can sometimes be hidden, and provides practical examples of quantifying and hedging exposures. For the specialist, the authors provide a detailed discussion of the mathematical foundations of risk management, and draw on their experience of hedging complex multi-asset class portfolios, providing practical advice and insights.

Provides a clear description of the risks faced by managers with equity, fixed income, commodity, credit and foreign exchange exposures
Elaborates methods of quantifying these risks
Discusses the various tools available for hedging, and how to choose optimal hedging instruments
Illuminates hidden risks such as counterparty, operational, human behavior and model risks, and expounds the importance and instability of model assumptions, such as market correlations, and their attendant dangers
Explains in clear yet effective terms the language of quantitative finance and enables a non-quantitative investment professional to communicate effectively with professional risk managers, "quants", clients and others

Providing thorough coverage of asset modeling, hedging principles, hedging instruments, and practical portfolio management, Hedging Market Exposures helps portfolio managers, bankers, transactors and finance and accounting executives understand the risks their business faces and the ways to quantify and control them.

Preface.

Introduction.

About the Authors.

1 The Economic Environment.

1.1 Introduction.

1.2 Inflation and Unemployment.

1.3 Central Banks and the Money Supply.

1.4 The Business Cycle.

1.5 Predicting the Future?

1.6 Economic Indicators.

2 Risk: An Introduction.

2.1 What Is Risk?

2.2 Risks of Financial Instruments.

2.3 Operational Risk.

2.4 What Risks Are in Your Portfolio? Hidden Hazards.

2.5 Hedging Market Risks.

3 Asset Modeling.

3.1 Asset Value.

3.2 Financial Models.

3.3 Valuation Principles.

3.4 Discount Rates Selection.

3.5 Cash Flow Projection and Asset Valuation.

3.6 Stochastic Asset Valuation.

3.7 The Monte Carlo Method.

3.8 Stochastic Extrapolation.

4 Market Exposures and Factor Sensitivities.

4.1 From Valuation to Responses and Sensitivities.

4.2 Response Matrix and Scenario Grid.

4.3 StressTesting.

4.4 Sensitivities.

4.5 Interest Rate Sensitivities: Duration, PV01, Convexity, Key Rate Measures.

4.6 Numerical Evaluation of Sensitivities.

4.7 Performance Attribution and Completeness Test.

5 Quantifying Portfolio Risks.

5.1 The Nature of Risk.

5.2 Standard Risk Measures.

5.3 Optimal Hedge Sizing.

5.4 Tail Risk Measures.

6 The Decision to Hedge.

6.1 To Hedge or Not to Hedge?

6.2 The Hedging Process.

7 Constructing a Hedge.

7.1 An Ideal Hedge.

7.2 A Sample Hedge.

7.3 Static and Dynamic Hedging.

7.4 Proxy Hedging.

7.5 Protection versus Upside.

7.6 Basis Risk.

7.7 Unintended Consequences.

7.8 Hedging Credit Risk.

7.9 Hedging Prepayment, Redemption, and other Human Behavior Risks.

7.10 Execution.

Appendix A: Basics of Probability Theory.

Appendix B: Elements of Statistics and Time Series Analysis.

References.

Glossary.

Index.

OLEG V. BYCHUK has eleven years of capital markets experience. This includes roles as head of Risk Management at Julius Baer Investment Management and head of Risk Management and Quantitative Research at Alternative Asset Managers. He has also held various positions at Citigroup Global Markets, OppenheimerFunds, and Deutsche Bank. Dr. Bychuk holds degrees from Columbia University (PhD) and Lomonosov Moscow State University and has published numerous articles.

BRIAN J. HAUGHEY is an Assistant Professor of Finance and Director of the Investment Center at Marist College. Previously, he headed the Mutual Fund Fee business in the Global Special Situations Group at Citigroup Global Markets. Prior to joining Citigroup, he was with Fitch Ratings.

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