Measuring and Managing Risk in Innovative Financial Instruments

Stuart M Turnbull


Introduction to 'Lessons from the Financial Crisis'


The Credit Crunch of 2007: What Went Wrong? Why? What Lessons Can be Learned?


Underwriting versus Economy: A New Approach to Decomposing Mortgage Losses


The Shadow Banking System and Hyman Minsky’s Economic Journey


The Collapse of the Icelandic Banking System


The Quant Crunch Experience and the Future of Quantitative Investing


No Margin for Error: The Impact of the Credit Crisis on Derivatives Markets


The Re-Emergence of Distressed Exchanges in Corporate Restructurings


Modelling Systemic and Sovereign Risks


Measuring and Managing Risk in Innovative Financial Instruments


Forecasting Extreme Risk of Equity Portfolios with Fundamental Factors


Limits of Implied Credit Correlation Metrics Before and During the Crisis


Another view on the pricing of MBSs, CMOs and CDOs of ABS


Pricing of Credit Derivatives with and without Counterparty and Collateral Adjustments


A Practical Guide to Monte Carlo CVA


The Endogenous Dynamics of Markets: Price Impact, Feedback Loops and Instabilities


Market Panics: Correlation Dynamics, Dispersion and Tails


Financial Complexity and Systemic Stability in Trading Markets


The Martingale Theory of Bubbles: Implications for the Valuation of Derivatives and Detecting Bubbles


Managing through a Crisis: Practical Insights and Lessons Learned for Quantitatively Managed Equity Portfolios


Active Risk Management: A Credit Investor’s Perspective


Investment Strategy Returns: Volatility, Asymmetry, Fat Tails and the Nature of Alpha

In the 2007–9 credit crisis, the issues of improper valuation and inadequate risk management in the use of credit derivatives were at the centre of the credit market turmoil. There has been much discussion about the use of such instruments as mortgage-backed securities, collateralised debt obligations (CDOs) and credit default swaps (CDSs). The crisis has raised the question of how we measure the risks of innovative financial products and manage those risks. Innovative financial instruments are typically illiquid and pose several challenges for their valuation and the measurement and management of the risks associated with them. Measuring risk at some specified time horizon requires the ability to price different assets in future states and to compute different risk measures. Managing risk requires the means to alter a risk profile, through either contractual mechanisms such as master agreements or institutions such as clearinghouses or via the use of hedging instruments. This chapter addresses some of the many issues that arise when a new form of financial instrument is introduced.

Innovation in financial instruments takes two forms: variations on existing types of instruments

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