VALUE AT RISK
VALUE AT RISK
The New Benchmark for Managing Financial Risk
THIRD EDITION
PHILIPPE JORION
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CONTENTS
PREFACE
THE RISK MANAGEMENT REVOLUTION
Risk management truly has experienced a revolution in the last few years. This was started by value at risk (VAR), a new method to measure financial-market risk that was developed in response to the financial disasters of the early 1990s. By now, the VAR methodology has spread well beyond derivatives and is totally changing the way institutions approach their financial risk.
The first edition of this book provided the first comprehensive description of value at risk. Published in 1996, it quickly established itself as an indispensable reference on VAR and has been called the industry standard. It has been translated into Chinese, Hungarian, Japanese, Korean, Polish, Portuguese, and Spanish.
A completely revised second edition followed in 2000. This edition had been vastly expanded in content, with the page count increasing from 332 to 544. This expansion reflected the new body of knowledge and wider applications of VAR methods.
Initially confined to measuring market risk, VAR is now being used to control and manage risk actively, well beyond derivatives. The VAR methodology is now helping us to quantify credit risk and operational risk, leading to the Holy Grail of firmwide risk management. The broader scope of this book was reflected in its new subtitle, which was changed from The New Benchmark for Controlling Market Risk to The New Benchmark for Managing Financial Risk.
Since 2000, the industry has experienced new developments that create a need for a new edition. This third edition has been thoroughly brought up-to-date, with new or revamped chapters on multivariate methods (including factor models, principal components, and copulas), VAR methods using extreme-value theory, risk budgeting, and portfolio optimization using VAR. The chapters on credit risk, operational risk, and integrated risk management have been substantially revised as well. All chapters now include the latest relevant developments in the field. To keep the size of this book manageable, less relevant topics have been dropped, including the chapter on the technology of risk that was fast becoming obsolete.
In addition, this book incorporates the most recent regulatory requirements, including Basel II, which helped the industry to clarify the measurement of credit and operational risks. To help readers, the book now uses Basel-compliant terminology. This edition also covers the latest financial disasters, including AIB and NAB. While such events still happen once in a while, their frequency seems to decrease over time, no doubt aided by the advent of risk management.
This new edition also draws risk management lessons from the Enron bankruptcy, the Argentina default, and the September 11 attacks. It incorporates the latest recommendations of the Counterparty Risk Management Policy Group.
Finally, because this book is used increasingly as a text in risk management courses, each chapter now has a list of questions that can be used as assignments to students or as mind-expanding exercises for inquisitive readers. All in all, this is a substantially expanded and improved edition.
WHAT IS VAR?
Value at risk traces it roots to the infamous financial disasters of the early 1990s that engulfed Orange County, Barings, Metallgesellschaft, Daiwa, and so many others. The common lesson of these disasters is that billions of dollars can be lost because of poor supervision and management of financial risks. Spurred into action, financial institutions and regulators turned to VAR, an easy-to-understand method for quantifying market risk.
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