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0071663703_Risk.rar
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First, we discuss the disaster in the convertible bond market during 2008
and pay particular attention to the difficulties faced by the model-intensive
convertible arbitrage strategy. Next, we review the activity in option markets
in the nineteenth century to explore the importance of modern theory
in pricing derivatives. This is followed by a section reviewing the linkage
between theory and practice in bridge building. It highlights the direction
taken by the engineering profession after the highly visible, catastrophic
failure of the Tacoma Narrows Bridge in 1940. The final section provides
concluding thoughts.
The goal of bringing together such disparate topics is to provide a broad
perspective on model risk. Some of the key issues addressed are: (1) How
can we best frame themes regarding model breakdowns during market
crises? (2) What can the careful study of the evolution of derivatives markets
and no-arbitrage pricing models suggest for robustifying market pract
ice against traumat ic shocks? (3) What can be learned from the
experiences of other disciplines that have suffered catastrophic failures
when moving from theory to reality?
There are some straightforward conclusions for this chapter. First, financial
engineers should study past crises and model breakdowns rather than
simply extrapolate from recent successes. Second, theoretical advances have
had a profound impact on the pricing of derivative securities and the mindset
for financial engineering, but the real world is tricky. Highly realistic
models may increase the likelihood of failure if they reduce the buffer
against factors glossed over by the model. For example, highly complex
no-arbitrage models may fail miserably when trading is not continuous
and arbitrage opportunities exist for a period of time (i.e., when liquidity
disappears).……………………
A book like this helps reduce the chance of a future breakdown in risk
management.
—Campbell R. Harvey, Professor
The Fuqua School of Business, Duke University
Inadequate valuation and risk management models have played their part
in triggering the recent economic turmoil felt around the world. Model
risk is thus becoming recognized by risk managers and financial engineers
as an important source of additional risk. This timely book, written
by experts in the field, will surely help them to measure and manage
this risk effectively.
—Fabrice Douglas Rouah, Ph.D., Vice President
Enterprise Risk Management
The Risk Modeling Evaluation Handbook provides a very timely and
extremely useful guide to the subtle and often difficult issues involved in
model risk—a subject which is only now gaining the prominence it should
always have had. Risk practitioners will find it an invaluable guide.
—Kevin Dowd, Professor of Financial Risk Management
Nottingham University Business School
This book collects authorative papers on a timely and important topic
written by academics and practitioners. Especially the latter combination
makes this book readable to a wide audience, and it should lead to many
new insights.
—Philip Hans Franses, Professor of Econometrics and Dean
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