Jawwad Farid - Models at Work: A Practitioners Guide to Risk Management

Models at Work

Global Financial Markets series

Global Financial Markets is a series of practical guides to the latest financial market tools, techniques and strategies. Written for practitioners across a range of disciplines it provides comprehensive but practical coverage of key topics in finance covering strategy, markets, financial products, tools and techniques and their implementation. This series will appeal to a broad readership, from new entrants to experienced practitioners across the financial services industry, including areas such as institutional investment; financial derivatives; investment strategy; private banking; risk management; corporate finance and M&A; financial accounting and governance; and many more.

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THE COMPLETE GUIDE TO HEDGE FUNDS AND HEDGE FUND STRATEGIES

Frances Cowell

RISK-BASED INVESTMENT MANAGEMENT IN PRACTICE (2nd Edition)

Practitioners Guide to the Active Management of Credit Risks

Jawwad Ahmed Farid

MODELS AT WORK

A Practitioners Guide to Risk Management

Guy Fraser-Sampson

INTELLIGENT INVESTING

A Guide to the Practical and Behavioural Aspects of Investment Strategy

Michael Hnseler

CREDIT PORTFOLIO MANAGEMENT

A Practitioners Guide to the Active Management of Credit Risks

Ross K. McGill

US WITHHOLDING TAX

Practical Implications of QI and FATCA

David Murphy

OTC DERIVATIVES, BILATERAL TRADING AND CENTRAL CLEARING

An Introduction to Regulatory Policy, Trading Impact and Systemic Risk

Gianluca Oricchio

PRIVATE COMPANY VALUATION

How Credit Risk Reshaped Equity Markets and Corporate Finance Valuation Tools

Andrew Sutherland and Jason Court

THE FRONT OFFICE MANUAL

The Definitive Guide to Trading, Structuring and Sales

Michael C. S. Wong and Wilson F. C. Chan (editors)

INVESTING IN ASIAN OFFSHORE CURRENCY MARKETS

The Shift from Dollars to Renminbi

Global Financial Markets series

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Models at Work

A Practitioners Guide to Risk Management

Jawwad Ahmed Farid

Jawwad Ahmed Farid 2014

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First published 2014 by

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To Ammi, Aba & Fawzia.

For all the times when you should have said no, but said yes

Contents

List of Figures

Part I

Part II

Part III

Part IV

Preface

Models at Work

I am not a Quant.

I always wanted to be one but it took a single meeting with Goldmans Firmwide risk team in London to clear any delusions I may have harbored. All remaining reservations were removed in the one PhD finance elective that I took with Maria Vassalou at Columbia. Despite Marias kindness and dedication, it was obvious in April 1999 that I was just an ordinary mortal and not a Quant.

In 1999, the realization wasnt heart breaking. Even if one couldnt live in the exotic world of high finance, the less exalted levels in the banking and trading world offered enough to keep you engaged and happy as a professional.

But that was then. The last six years have shown that the impact of quantitative models travels beyond the inner circle of the more mathematically inclined amongst us. Imagine being a board member at a large bank or a financial institution; imagine the board meeting dossier filled with numbers and graphs that come with no cheat sheet or Rosetta Stone and then envisage the need for you, as a board member, to initial and certify it all with your name and reputation.

The challenge is that armed without a PhD in the subject or years of experience on the trading desk we are hopelessly lost when it comes to dissecting models at work. Even if one wants to learn there is little material available in a language that mortals can understand. The foundation of the field of risk management is based on well-aged sciences of mathematics and statistics. It is but natural that books heavy on mathematical and statistical treatment of the subject are common and abundant, while those relying on simple layperson language and do-it-yourself modeling in EXCEL are not.

Ideally, a book should introduce a framework for managing risk and follow it through with a number of real-world illustrative examples with numbers and data. If you are interested, it should allow you to build and test simple models that you can then use to strengthen your understanding of the conditions under which models can break down or predict where things can go wrong. A great text should educate you enough to not only ask the right questions but also evaluate and digest the answers provided.

Over the last decade, as we put together teaching notes for participants in our workshops for bankers, traders, treasurers and executive MBA students, we found that the above design on teaching risk management worked well. The challenge most professionals face is not with theoretical derivations but with practical applications in the real world.

What is this book about?

The book uses four sections to present frameworks, tools, cases and context around risk management. Here is a quick review of each section:

Part I Risk

A framework for thinking about risk begins with an evaluation of complexity in analysis versus complexity in models. The chapters in this section start with an introduction to dealing with volatility, measuring risk using Value at Risk, managing risk using target accounts and ends with two short chapters on risk policy and risk regulation.