An irreplaceable roadmap to modern risk management from renowned experts on the subject
Edited by a co-founder and the former Chief Risk Officer of BlackRock - the world’s largest asset manager - BlackRock’s Guide to Fixed-Income Risk Management delivers an insightful blueprint to the implementation of a comprehensive investment risk management framework for buy-side firms. Leveraging the unprecedented academic and professional experience of current and former senior leaders in BlackRock’s risk and portfolio management functions, as well as trading, financial modeling, and analytics experts, the book serves a practitioner’s guide to investment risk management, leveraging BlackRock’s risk management framework. The included chapters combine to provide chief investment officers, risk managers, portfolio managers, researchers, and compliance professionals an approach to investment risk management well-suited for today's and tomorrow's markets. The book also presents:
- Critical elements that underpin a strong risk management program and culture
- Fixed income risk management concepts and theories that can be applied to other asset classes
- Lessons learned from financial crises and the COVID-19 Pandemic
Ideal for undergraduate students and students and scholars of business, finance, and risk management, BlackRock’s Guide to Fixed-Income Risk Management is a one-of-a-kind combination of modern theory with proven, practical risk management strategies.
Table of Contents
Frequently Used Abbreviations xvii
Foreword xxi
Preface xxiii
Acknowledgments xxxi
SECTION I An Approach to Fixed-Income Investment Risk Management 1
CHAPTER 1 An Investment Risk Management Paradigm 3
Bennett W. Golub and Rick Flynn
1.1 Introduction 3
1.2 Elements of Risk Management 4
1.3 BlackRock’s Investment and Risk Management Approach 6
1.4 Introduction to the BlackRock Investment Risk Management Paradigm 7
CHAPTER 2 Parametric Approaches to Risk Management 11
Bennett W. Golub and Leo M. Tilman
2.1 Introduction 11
2.2 Measuring Interest Rate Exposure: Analytical Approaches 12
2.3 Measuring Interest Rate Exposure: Empirical Approaches 30
2.4 Measuring Yield Curve Exposure 34
2.5 Measuring and Managing Volatility Related Risks 40
2.6 Measuring Credit Risk 47
2.7 Measuring Mortgage-Related Risks 50
2.8 Measuring Impact of Time 52
CHAPTER 3 Modeling Yield Curve Dynamics 59
Bennett W. Golub and Leo M. Tilman
3.1 Probability Distributions of Systematic Risk Factors 59
3.2 Principal Component Analysis: Theory and Applications 61
3.3 Probability Distributions of Interest Rate Shocks 75
CHAPTER 4 Portfolio Risk: Estimation and Decomposition 81
Amandeep Dhaliwal and Tom Booker
4.1 Introduction 81
4.2 Portfolio Volatility and Factor Structure 83
4.3 Covariance Matrix Estimation 85
4.4 Ex Ante Risk and VaR Methodologies 93
4.5 Introduction to Risk Decomposition 103
4.6 Alternative Approaches to Risk Decomposition 104
4.7 Risk Decomposition Using CTR 108
4.8 Risk Decomposition Through Time 116
4.9 Risk Decomposition: Summary 119
CHAPTER 5 Market-Driven Scenarios: An Approach for Plausible Scenario Construction 125
Bennett W. Golub, David Greenberg, and Ronald Ratcliffe
5.1 Introduction 125
5.2 Implied Stress Testing Framework 127
5.3 Developing Useful Scenarios 134
5.4 A Market-Driven Scenario Example: Brexit 136
5.5 Conclusion 142
CHAPTER 6 A Framework to Quantify and Price Geopolitical Risks 145
Catherine Kress, Carl Patchen, Ronald Ratcliffe, Eric Van Nostrand, and Kemin Yang
6.1 Introduction 145
6.2 Setting the Scene 146
6.3 BlackRock’s Framework for Analyzing Geopolitical Risks 149
6.4 Global Trade Deep Dive 149
6.5 What Is Already Priced In? 153
6.6 Taking Action 156
6.7 Caveats and Cautions 159
CHAPTER 7 Liquidity Risk Management 163
Bennett W. Golub, Philip Sommer, Stefano Pasquali, Michael Huang, Kristen Walters, and Nikki Azznara
7.1 Introduction 163
7.2 A Brief History of Liquidity Risk Management 164
7.3 A Fund Liquidity Risk Framework 166
7.4 Asset Liquidity 166
7.5 Redemption Risk 169
7.6 Liquidity Stress Testing 170
7.7 Extraordinary Measures 171
7.8 Fixed-Income Data Availability Limitations 171
7.9 Conclusion 181
CHAPTER 8 Using Portfolio Optimization Techniques to Manage Risk 183
Alex Ulitsky, Bennett W. Golub, Leo M. Tilman, and Jack Hattem
8.1 Risk Measurement Versus Risk Management 183
8.2 Typical Fixed-Income Hedges 185
8.3 Parametric Hedging Techniques 187
8.4 Generalized Approach to Hedging 189
8.5 Advanced Portfolio Optimization and Risk Management Techniques 207
CHAPTER 9 Risk Governance 219
Bennett W. Golub
9.1 Introduction 219
9.2 Risk Scan Standard Framework 219
9.3 Risk and Performance Target (RPT) Framework 221
9.4 Governance 223
CHAPTER 10 Risk-Return Awareness and Behavioral Finance 225
Emily Haisley and Nicky Lai
10.1 Introduction 225
10.2 Portfolio and Risk Manager Partnership 226
10.3 Behavioral Risk Management for Fixed Income 227
10.4 Decision-Making Analytics 229
10.5 Investment Process 235
10.6 Conclusion 241
CHAPTER 11 Performance Attribution 243
Reade Ryan and Carol Yu
11.1 Introduction 243
11.2 Brinson Attribution and Beyond 244
11.3 Factor-Based Attribution 252
11.4 Equity Fundamental Factor-Based Attribution 256
CHAPTER 12 Performance Analysis 259
Mark Paltrowitz, Mark Temple-Jones, Viola Dunne, and Christopher Calingo
12.1 Introduction 259
12.2 Performance Governance 260
12.3 Performance Metrics 260
12.4 Conclusion 266
CHAPTER 13 Evolving the Risk Management Paradigm 267
Bennett W. Golub, Michael Huang, and Joe Buehlmeyer
13.1 Introduction 267
13.2 Traditional Buy-Side Risk Management Framework 268
13.3 Evolving the IRMP: In Pursuit of Investment Risk Management at Scale 268
13.4 Risk Governance 270
13.5 Supporting Risk Governance Through Technology 270
13.6 Implementing a Risk Governance Framework Through Aladdin 271
13.7 Aladdin's Risk Radar Example 271
13.8 Conclusion 276
SECTION II Fixed-Income Risk Management - Then and Now 277
CHAPTER 14 The Modernization of the Bond Market 279
Daniel Veiner, Stephen Laipply, Carolyn Weinberg, Samara Cohen, Vasiliki Pachatouridi, and Hui Sien Koay
14.1 Charting the Evolution of Bond Markets 279
14.2 The Development of an Index-Based Ecosystem 285
14.3 Implications for Investing, Portfolio Management, and Risk Management 289
14.4 The Future State of Portfolio Construction 290
14.5 Conclusion 290
CHAPTER 15 The LIBOR Transition 293
Jack Hattem
15.1 Introduction 293
15.2 Implications to Portfolio and Risk Management 295
15.3 Shift from LIBOR to SOFR 295
15.4 Risk Management Impact and Coordination 297
15.5 Reflections on a Benchmark Reforms 298
CHAPTER 16 Derivatives Reform: The Rise of Swap Execution Facilities and Central Counterparties 301
Eileen Kiely and Jack Hattem
16.1 The Call for Change: 2008 Global Financial Crisis 301
16.2 The Value of Derivatives in Fixed-Income Portfolios 302
16.3 Trading Fixed-Income Derivatives: The Rise of SEFs 304
16.4 Clearing Fixed-Income Derivatives: The Rise of CCPs 305
16.5 CCP Risk Mitigation Techniques 306
16.6 The Call for Change: Market Participants Ask for Stronger CCPs 308
16.7 Conclusion 311
SECTION III Lessons from the Credit Crisis and Coronavirus Pandemic 313
CHAPTER 17 Risk Management Lessons Worth Remembering from the Credit Crisis of 2007-2009 315
Bennett W. Golub and Conan Crum
17.1 Introduction 315
17.2 The Paramount Importance of Liquidity 316
17.3 Investors in Securitized Products Need to Look Past the Data to the Underlying Behavior of the Assets 326
17.4 Certification Is Useless During Systemic Events 331
17.5 Market Risk Can Change Dramatically 332
17.6 The Changing Nature of Market Risk 336
17.7 By the Time a Crisis Strikes, It’s Too Late to Start Preparing 337
17.8 Conclusion 338
CHAPTER 18 Reflections on Buy-Side Risk Management After (or Between) the Storms 341
Bennett W. Golub and Conan Crum
18.1 Introduction 341
18.2 Risk Management Requires Institutional Buy-In 341
18.3 The Alignment and Management of Institutional Interests 342
18.4 Getting Risk Takers to Think Like Risk Managers 345
18.5 Independent Risk Management Organizations 345
18.6 Clearly Define Fiduciary Obligations 347
18.7 Bottom-Up Risk Management 348
18.8 Risk Models Require Constant Vigilance 349
18.9 Risk Management Does Not Mean Risk Avoidance 350
CHAPTER 19 Lessons Worth Considering from the COVID-19 Crisis 353
Barbara Novick, Joanna Cound, Kate Fulton, and Winnie Pun
19.1 Introduction 353
19.2 Background 354
19.3 Core Principles Underpinning Recommendations 354
19.4 March 2020: Capital Markets Highlights and Official Sector Intervention 355
19.5 COVID-19 Lessons: What Worked and What Needs to be Addressed 357
19.6 Recommendations to Enhance the Resilience of Capital Markets 363
19.7 Concerns with Macroprudential Controls 368
19.8 Conclusion 369
19.9 Postscript 369
Notes 370
Bibliography 373
About the Website 383
About the Editor 385
About the Contributors 387
Index 391
