Taking due account of extreme events when constructing portfolios of assets or liabilities is a key discipline for market professionals. Extreme events are a fact of life in how markets operate.In Extreme Events: Robust Portfolio Construction in the Presence of Fat Tails, leading expert Malcolm Kemp shows readers how to analyse market data to uncover fat-tailed behaviour, how to incorporate expert judgement in the handling of such information, and how to refine portfolio construction methodologies to make portfolios less vulnerable to extreme events or to benefit more from them.This is the only text that combines a comprehensive treatment of modern risk budgeting and portfolio construction techniques with the specific refinements needed for them to handle extreme events. It explains in a logical sequence what constitutes fat-tailed behaviour and why it arises, how we can analyse such behaviour, at aggregate, sector or instrument level, and how we can then take advantage of this analysis.Along the way, it provides a rigorous, comprehensive and clear development of traditional portfolio construction methodologies applicable if fat-tails are absent. It then explains how to refine these methodologies to accommodate real world behaviour.Throughout, the book highlights the importance of expert opinion, showing that even the most data-centric portfolio construction approaches ultimately depend on practitioner assumptions about how the world might behave. The book includes:Key concepts and methods involved in analysing extreme eventsA comprehensive treatment of mean-variance investing, Bayesian methods, market consistent approaches, risk budgeting, and their application to manager and instrument selectionA systematic development of the refinements needed to traditional portfolio construction methodologies to cater for fat-tailed behaviourLatest developments in stress testing and back testing methodologiesA strong focus on the practical implementation challenges that can arise at each step in the process and on how to overcome these challenges"Understanding how to model and analyse the risk of extreme events is a crucial part of the risk management process. This book provides a set of techniques that allow practitioners to do this comprehensively."Paul Sweeting, Professor of Actuarial Science, University of Kent"How can the likeliness of crises affect the construction of portfolios? This question is highly topical in times where we still have to digest the last financial collapse. Malcolm Kemp gives the answer. His book is highly recommended to experts as well as to students in the financial field."Christoph Krischanitz, President Actuarial Association of Austria, Chairman WG "Market Consistency" of Groupe Consultatif
Achieving market consistency can be challenging, even for the most established finance practitioners. In Market Consistency: Model Calibration in Imperfect Markets, leading expert Malcolm Kemp shows readers how they can best incorporate market consistency across all disciplines. Building on the author's experience as a practitioner, writer and speaker on the topic, the book explores how risk management and related disciplines might develop as fair valuation principles become more entrenched in finance and regulatory practice.This is the only text that clearly illustrates how to calibrate risk, pricing and portfolio construction models to a market consistent level, carefully explaining in a logical sequence when and how market consistency should be used, what it means for different financial disciplines and how it can be achieved for both liquid and illiquid positions. It explains why market consistency is intrinsically difficult to achieve with certainty in some types of activities, including computation of hedging parameters, and provides solutions to even the most complex problems.The book also shows how to best mark-to-market illiquid assets and liabilities and to incorporate these valuations into solvency and other types of financial analysis; it indicates how to define and identify risk-free interest rates, even when the creditworthiness of governments is no longer undoubted; and it explores when practitioners should focus most on market consistency and when their clients or employers might have less desire for such an emphasis.Finally, the book analyses the intrinsic role of regulation and risk management within different parts of the financial services industry, identifying how and why market consistency is key to these topics, and highlights why ideal regulatory solvency approaches for long term investors like insurers and pension funds may not be the same as for other financial market participants such as banks and asset managers.
A report from the International Monetary Fund.
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