It was with a mixture of keen anticipation and some trepidation that I recently agreed to become the new (and only second) editor of The Journal of Risk (JOR). It will not be easy following Professor Philippe Jorion, the first editor. He succeeded where most fail, namely, transforming a fledgling journal into a successful and respected publication. The task in his case was even more challenging, as it is the goal of JOR to publish papers that are not only rigorous and innovative but that are also focused on solving practical problems in risk management. There can be no doubt as to the success of his efforts.
Philippe recruited to his aid an exceptional Editorial Board, and I have emulated him in this respect. I am very excited (and comforted) to be joined by so many of the leading lights in risk management in the continued effort to build on Philippe's accomplishments with JOR. Over time I hope, with the help of the Editorial Board, to put my own stamp on JOR. Initially I am continuing to work with Philippe to see through to completion those papers submitted during his tenure as Editor.
The papers in this issue tackle a broad range of risk management problems. In the first paper, Gilli, Këllezi and Hysi examine some practical problems of portfolio optimization with downside risk measures. They explain why gradient based, quadratic programming methods may be inefficient or fail. The authors then detail a heuristic technique, threshold accepting, and employ this technique in comparing optimal portfolios obtained using value at-risk, expected shortfall, maximum loss and Omega.
Géczy, Minton and Schrand then depart from most of the previous empirical literature on corporate risk management by examining how firms use multiple, interrelated strategies to manage multiple sources of risk. Their focus is on the natural gas pipeline industry where, as a result of regulatory changes, firms have been faced with new and changing risks. They examine the time-series trends in risk management actions and the characteristics of the firms that choose particular combinations.
Finnerty examines the costs of moral hazard risk, such as the risk from breaching of a contractual obligation. He develops a contingent claims approach for valuing this risk, using as an example an implied contract between thrifts and the government that created an (accounting) asset for investors taking over troubled thrifts. By recognizing the existence of real options granted as a result of this implied contract, Finnerty demonstrates that an option approach improves on the traditional method of discounting the expected cashflow of lost profits.
Following this, de Malherbe looks at the pricing effects of the lack of uniformity in default events that are enumerated in CDS covenants. These variations arise from both the evolution of these contracts over time and idiosyncratic practices in the enumeration of default events. Such variations give rise to a form of basis risk within a book of CDS. Unfortunately, there is no active market for trading these basis risks. de Malherbe develops both a framework for quantifying these variations and a methodology for adjusting the price of a CDS.