Risk Management and Financial Institutions - Hull John C.

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John C. Hull

      Risk Management and Financial Institutions

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      Risk Management and Financial Institutions

      Fourth Edition

      JOHN C. HULL

      Cover image: ©iStock.com/Pinkypills

      Cover design: Wiley

      Copyright © 2015 by John C. Hull. All rights reserved.

      Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

      The Third Edition was published by John Wiley & Sons, Inc. in 2012. The first and second editions of this book was published by Prentice Hall in 2006 and 2009.

      Published simultaneously in Canada.

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       Library of Congress Cataloging-in-Publication Data:

      Hull, John, 1946–

      Risk management and financial institutions / John C. Hull. – Fourth Edition.

      pages cm. – (Wiley finance series)

      Includes index.

      ISBN 978-1-118-95594-9 (paper); ISBN 978-1-118-95596-3 (ePDF);

      ISBN 978-1-118-95595-6 (ePUB)

      1. Risk management. 2. Financial institutions – Management. I. Title.

      HD61.H83 2015

      332.1068′1 – dc23

      2014037477

To Michelle, Peter, and David

      Business Snapshots

      Preface

      Risk management practices and the regulation of financial institutions have continued to evolve in the past three years. Risk Management and Financial Institutions has been expanded and updated to reflect this. Like my other popular text Options, Futures, and Other Derivatives, the book is designed to be useful to practicing managers as well as college students. Those studying for GARP and PRMIA qualifications will find the book particularly helpful.

      The book is appropriate for university courses in either risk management or financial institutions. It is not necessary for students to take a course on options and futures markets prior to taking a course based on this book. But if they have taken such a course, some of the material in the first nine chapters does not need to be covered.

      The level of mathematical sophistication and the way material is presented have been managed carefully so that the book is accessible to as wide an audience as possible. For example, when covering copulas in Chapter 11, I present the intuition followed by a detailed numerical example; when covering maximum likelihood methods in Chapter 10 and extreme value theory in Chapter 13, I provide numerical examples and enough details for readers to develop their own Excel spreadsheets. I have also provided my own Excel spreadsheets for many applications on my website:

      www-2.rotman.utoronto.ca/~hull

      This is a book about risk management, so there is very little material on the valuation of derivatives. (This is the main focus of my other two books, Options, Futures, and Other Derivatives and Fundamentals of Futures and Options Markets.) The appendices at the end of the book include material that summarizes some of the valuation key results that are important in risk management, and the DerivaGem software can be downloaded from my website.

      NEW MATERIAL

      The fourth edition has been fully updated and contains much new material. In particular:

      1. There is a new chapter comparing scenario analysis to valuation (Chapter 7). The chapter introduces the reader to the statistical processes often assumed for market variables (without any stochastic calculus), explains Monte Carlo simulation, and distinguishes between the real and risk-neutral worlds.

      2. There is a new chapter on the Fundamental Review of the Trading Book (Chapter 17). This is an important new proposal from the Basel Committee.

      3. There is a new chapter on margin, OTC markets, and central counterparties (CCPs) (Chapter 18). This covers recent developments in the trading of over-the-counter derivatives and introduces the reader to a number of credit risk issues.

      4. There is a new chapter on enterprise risk management (Chapter 27). This discusses risk appetite, risk culture, and the importance of taking a holistic approach to risk management.

      5. The sequencing of the material in the book has been improved. For example, the calculation of value at risk and expected shortfall is now covered immediately after these risk measures are introduced. The book is now divided into six parts: financial institutions and their trading, market risk, regulation, credit risk, other topics, and appendices.

      6. There is more emphasis throughout the book on the use of expected shortfall. This is consistent with the Basel Committee’s plans for changing the way market risk capital

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