Quantitative Enterprise Risk Management

By Mary R. Hardy and David Saunders · Cambridge University Press · 2022

An introduction to enterprise risk management (ERM) that integrates quantitative and qualitative approaches and motivates key mathematical and statistical methods with real-world cases, both successes and failures. Its narrative runs from risk governance, through risk identification, risk modelling and risk mitigation, to the holistic topics of regulation, behavioural biases and crisis management. Worked examples and end-of-chapter exercises support the reader.

On the syllabus

Exam CFE-101 — Quantitative Enterprise Risk Management, Hardy, Mary and Saunders, David, 2022: Ch. 13 Liquidity Risk (1.3a, 2.1a, 2.2h, 3.1a); Ch. 2 Risk Taxonomy (1.2c, 2.1a); Ch. 14 Model Risk and Governance (2.1a, 2.2f, 2.2g); Ch. 3 Risk Measures (2.2b, 3.3c); Ch. 10 Economic Scenario Generators (2.2g); Ch. 15 Risk Mitigation Using Options and Derivatives (3.2a, 3.2c); Ch. 18 Risk-Adjusted Measures of Profit and Capital Allocation, excluding section 18.6 (3.3b-3.3e), where the candidate is not responsible for demonstrating whether or how the fair allocation criteria are met for any of the capital allocation methods in section 18.4.

Exam CP-351 — Quantitative Enterprise Risk Management, Hardy, Mary and Saunders, David, 2022: Ch. 2 Risk Taxonomy (1c); Ch. 8 Market Risk Models (2b); Ch. 6 Copulas (3b); Ch. 7 Stress Testing (3c); Ch. 14 Model Risk and Governance (3d); Ch. 15 Risk mitigation using options and derivatives (3e); Ch. 16 Risk Transfer (3g).

Preface

1 Introduction to Enterprise Risk Management

1.1 Summary
1.2 Risk and Uncertainty
1.3 Insurance Risk Management
1.4 Financial Risk Management
1.5 Actuarial Risk Management
1.6 Asset-Liability Management
1.7 Quantitative Risk Management
1.8 Project Risk Management
1.9 Operational Risk Management
1.10 Crisis Management
1.11 Enterprise Risk Management (ERM)
1.12 The ERM Process
1.13 Risk Governance
1.14 Risk Budgeting
1.15 Notes and Further Reading
1.16 Exercises

2 Risk Taxonomy

2.1 Summary
2.2 Introduction
2.3 External Risks: Financial Markets
2.4 External Risks: Macroeconomic
2.5 External Risks: Political and Regulatory
2.6 External Risks: Environmental
2.7 Internal Risks: Operational
2.8 Internal Risks: Strategic
2.9 Reputational Risk
2.10 Risk Management Examples
2.11 Notes and Further Reading
2.12 Exercises

3 Risk Measures

3.1 Summary
3.2 Introduction
3.3 Risk Measures for Capital Requirements
3.4 Coherent Risk Measures
3.5 Estimating Risk Measures Using Monte Carlo Simulation
3.6 Quantifying Uncertainty in VaR and Expected Shortfall Estimates
3.7 Other Measures of Risk
3.8 Notes and Further Reading
3.9 Exercises

4 Frequency-Severity Analysis

4.1 Summary
4.2 Introduction
4.3 Modelling Loss Frequency
4.4 Loss Severity Distributions
4.5 The Aggregate Loss Distribution
4.6 Risk Measures for the Aggregate Loss Distribution
4.7 Notes and Further Reading
4.8 Exercises
Appendix: R Code for FFT and Panjer Recursions

5 Extreme Value Theory

5.1 Summary
5.2 Introduction
5.3 Distributions of Block Maxima
5.4 Distribution of Excess Losses Over a Threshold
5.5 Example: US Hurricane Losses, 1940–2012
5.6 Notes and Further Reading
5.7 Exercises

6 Copulas

6.1 Summary
6.2 Introduction
6.3 The Multivariate Normal Distribution
6.4 The Multivariate Student’s t (MVT) Distribution
6.5 What Is a Copula?
6.6 Examples of Copulas
6.7 Survival Copulas
6.8 Copula Bounds
6.9 Measures of Dependency
6.10 Tail Dependence
6.11 Archimedean Copulas
6.12 Copula Estimation
6.13 Monte Carlo Simulation of Bivariate Copulas
6.14 Notes and Further Reading
6.15 Exercises

7 Stress Testing

7.1 Summary
7.2 Introduction
7.3 Stress and Scenario Testing
7.4 Purposes and Uses of Stress Testing
7.5 Developing Scenarios
7.6 Regulatory Stress Tests
7.7 Stress and Scenario Testing: Failures and Successes
7.8 Notes and Further Reading
7.9 Exercises

8 Market Risk Models

8.1 Summary
8.2 Introduction
8.3 Empirical Behaviour of Equity Prices
8.4 Geometric Brownian Motion (GBM)
8.5 The Independent Lognormal Model (ILN)
8.6 The GARCH Model
8.7 Regime-Switching Models
8.8 Fitting Models to Returns Data
8.9 Choosing a Model
8.10 Notes and Further Reading
8.11 Exercises

9 Short-Term Portfolio Risk

9.1 Summary
9.2 Introduction
9.3 VaR and Expected Shortfall for Portfolios
9.4 VaR and Expected Shortfall for Portfolios of Assets and Derivatives
9.5 Empirical VaR and Expected Shortfall
9.6 Backtesting
9.7 Notes and Further Reading
9.8 Exercises

10 Economic Scenario Generators

10.1 Summary
10.2 Introduction
10.3 Considerations for the ESG
10.4 Economic Scenario Generator Design
10.5 Model Fitting and Robustness
10.6 A Pension Example
10.7 Notes and Further Reading
10.8 Exercises

11 Interest Rate Risk

11.1 Summary
11.2 The Term Structure of Interest Rates
11.3 Interest Rate Sensitive Securities
11.4 Duration and Convexity
11.5 Hedging Interest Rate Sensitive Portfolios
11.6 Behaviour of the Interest Rate Term Structure
11.7 Notes and Further Reading
11.8 Exercises

12 Credit Risk

12.1 Summary
12.2 Types of Credit Risk
12.3 Basic Credit Model Components
12.4 Modelling Individual Default Behaviour
12.5 Portfolio Credit Risk Models
12.6 Notes and Further Reading
12.7 Exercises

13 Liquidity Risk

13.1 Summary
13.2 Introduction
13.3 Liquidity Metrics
13.4 Liquidity Risk Management
13.5 Liquidity Stress Testing
13.6 Liquidity-Adjusted Risk Measures
13.7 Emergency Contingency Funding Plan
13.8 Notes and Further Reading
13.9 Exercises

14 Model Risk and Governance

14.1 Summary
14.2 Introduction
14.3 Model Risk
14.4 The Lifecycle of a Model
14.5 Model and Parameter Risk
14.6 Model Governance
14.7 Risk Treatment for Model Risk
14.8 Notes and Further Reading
14.9 Exercises

15 Risk Mitigation Using Options and Derivatives

15.1 Summary
15.2 Introduction
15.3 Market Risk
15.4 Hedging Market Risk with Option Combinations
15.5 Interest Rate Derivatives
15.6 Credit Risk
15.7 Exchange Rate Risk
15.8 Commodity Price Hedging
15.9 Notes and Further Reading
15.10 Exercises

16 Risk Transfer

16.1 Summary
16.2 Introduction
16.3 Risk Transfer through Traditional Insurance
16.4 Captive Insurance
16.5 Securitization of Insurance Risk
16.6 Catastrophe Bonds
16.7 Other Forms of Securitized P&C Insurance
16.8 Longevity and Mortality Risk Securitization
16.9 Notes and Further Reading
16.10 Exercises

17 Regulation of Financial Institutions

17.1 Summary
17.2 Introduction
17.3 Basel II and III
17.4 Solvency II
17.5 Notes and Further Reading
17.6 Exercises

18 Risk-Adjusted Measures of Profit and Capital Allocation

18.1 Summary
18.2 Risk-Adjusted Performance Measures
18.3 Economic Capital Allocation: Objectives
18.4 Capital Allocation: Methods
18.5 Euler Allocation Methods
18.6 Capital Allocation Based on Default Cost
18.7 Using RAROC and Capital Allocation
18.8 Further Reading
18.9 Exercises

19 Behavioural Risk Management

19.1 Summary
19.2 Introduction
19.3 Bias and Decision-Making
19.4 Overcoming Bias
19.5 Cumulative Prospect Theory
19.6 Notes and Further Reading
19.7 Exercises

20 Crisis Management

20.1 Summary
20.2 Introduction
20.3 Examples of Crises and Responses
20.4 Crisis Preparation
20.5 Crisis Response
20.6 Post Crisis
20.7 Ethics, Governance, and Crisis Management
20.8 Further Reading
20.9 Exercises

Appendix A Probability and Statistics Review

A.1 Summary
A.2 Introduction
A.3 Random Variables
A.4 Moments and Quantiles
A.5 Important Distributions
A.6 Maximum Likelihood Estimation
A.7 Bayesian Statistics
A.8 Monte Carlo Simulation
A.9 Multivariate Distributions

Bibliography

Index

Sources

Quantitative Enterprise Risk Management (Cambridge University Press, 2022), table of contents — the chapter and section headings and their numbering, as the publisher prints them
Quantitative Enterprise Risk Management (Cambridge University Press, 2022), front matter — the title page, imprint (first published 2022, ISBN 978-1-009-09846-5) and the publisher's description used for the lead
CFE 101 Syllabus, Nov 2026/Mar 2027/Jul 2027 (SOA) — the citation, the chapters assigned, the exclusion of section 18.6 and the learning outcomes for CFE 101
CP-351 Syllabus, Nov 2026/Mar 2027/Jul 2027 (SOA) — the citation, the chapters assigned and the learning outcomes for CP-351