Table of Contents

PART ONE: INTRODUCTION.

What are Value-at-Risk and Risk Budgeting?

Value-at-Risk of a Simple Equity Portfolio.

PART TWO: TECHNIQUES OF VALUE-AT-RISK AND STRESS TESTING.

The Delta-Normal Method.

Historical Simulation.

The Delta-Normal Method for a Fixed Income Portfolio.

Monte Carlo Simulation.

Using Factor Models to Compute the VaR of Equity Portfolios.

Using Principal Components to Compute the VaR of Fixed-Income Portfolios.

Stress Testing.

PART THREE: RISK DECOMPOSITION AND RISK BUDGETING.

Decomposing Risk.

A "Long-Short" Hedge Fund Manager.

Aggregating and Decomposing the Risks of Large Portfolios.

Risk Budgeting and the Choice of Active Managers.

PART FOUR: REFINEMENTS OF THE BASIC METHODS.

Delta-Gamma Approaches.

Variants of the Monte Carlo Approach.

Extreme Value Theory and VaR.

PAART FIVE: LIMITATIONS OF VALUE-AT-RISK.

VaR Is Only an Estimate.

Gaming the VaR.

Coherent Risk Measures.

PART SIX: CONCLUSION.

A Few Issues in Risk Budgeting.

References.

Index.

About the Author

NEIL D. PEARSON, PhD, is an Associate Professor of Finance at the University of Illinois at Urbana-Champaign. His research includes work on the development, estimation, and evaluation of models for pricing and hedging various derivatives and other financial instruments. Dr. Pearson has published papers in a number of academic journals, and is an Associate Editor of both the Journal of Financial Economics and the Journal of Financial and Quantitative Analysis. He has consulted for a number of U.S. and international banks, working on term structure models, the evaluation of derivatives pricing models, and issues that arise in the computation of Value-at-Risk measures. He received his PhD from the Massachusetts Institute of Technology.