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Portfolio risk forecasting has been and continues to be an active research field for both academics and practitioners. Almost all institutional investment management firms use quantitative models for their portfolio forecasting, and researchers have explored models' econometric foundations, relative performance, and implications for capital market behavior and asset pricing equilibrium.Portfolio Risk Analysisprovides an insightful and thorough overview of financial risk modeling, with an emphasis on practical applications, empirical reality, and historical perspective.Beginning with mean-variance analysis and the capital asset pricing model, the authors give a comprehensive and detailed account of factor models, which are the key to successful risk analysis in every economic climate. Topics range from the relative merits of fundamental, statistical, and macroeconomic models, to GARCH and other time series models, to the properties of the VIX volatility index. The book covers both mainstream and alternative asset classes, and includes in-depth treatments of model integration and evaluation. Credit and liquidity risk and the uncertainty of extreme events are examined in an intuitive and rigorous way. An extensive literature review accompanies each topic. The authors complement basic modeling techniques with references to applications, empirical studies, and advanced mathematical texts.This book is essential for financial practitioners, researchers, scholars, and students who want to understand the nature of financial markets or work toward improving them.

Table of Contents

Acknowledgmentsp. xi
Introductionp. xiii
Key Notationp. xix
Measures of Risk and Returnp. 1
Measuring Returnp. 1
The Key Portfolio Risk Measuresp. 6
Risk-Return Preferences and Portfolio Optimizationp. 12
The Capital Asset Pricing Model and Its Applications to Risk Analysisp. 23
The Objectives and Limitations of Portfolio Risk Analysisp. 31
Unstructured Covariance Matricesp. 36
Estimating Return Covariance Matricesp. 36
The Error-Maximization Problemp. 47
Portfolio Choice as Decision Making under Uncertaintyp. 54
Industry and Country Riskp. 61
Industry-Country Component Modelsp. 61
Empirical Evidence on the Relative Magnitudes of Country and Industry Risksp. 73
Sector-Currency Models of Corporate Bond Returnsp. 77
Statistical Factor Analysisp. 79
Types of Factor Modelsp. 79
Approximate Factor Modelsp. 82
The Arbitrage Pricing Theoryp. 86
Small-n Estimation Methodsp. 88
Large-n Estimation Methodsp. 93
Number of Factorsp. 98
The Macroeconomy and Portfolio Riskp. 101
Estimating Macroeconomic Factor Modelsp. 101
Event Studies of Macroeconomic Announcementsp. 110
Macroeconomic Policy Endogeneityp. 112
Business Cycle Betasp. 115
Empirical Fit and the Relative Value of Macroeconomic Factor Modelsp. 116
Security Characteristics and Pervasive Risk Factorsp. 117
Equity and Fixed-Income Characteristicsp. 117
Characteristic-Based Factor Models of Equitiesp. 122
The Fama-French Model and Extensionsp. 130
The Semiparametric Approach to Characteristic-Based Factor Modelsp. 132
Measuring and Hedging Foreign Exchange Riskp. 134
Definitions of Foreign Exchange Riskp. 134
Optimal Currency Hedgingp. 142
Currency Covariances with Stock and Bond Returnsp. 149
Macroeconomic Influences on Currency Returnsp. 151
Integrated Risk Modelsp. 155
Global and Regional Integration Trendsp. 155
Risk Integration across Asset Classesp. 158
Segmented Asset Allocation and Security Selectionp. 159
Integrated Risk Modelsp. 162
Dynamic Volatilities and Correlationsp. 167
GARCH Modelsp. 167
Stochastic Volatility Modelsp. 178
Time Aggregationp. 180
Downside Correlationp. 181
Option-Implied Volatilityp. 184
The Volatility Term Structure at Long Horizonsp. 187
Time-Varying Cross-Sectional Dispersionp. 188
Portfolio Return Distributionsp. 191
Characterizing Return Distributionsp. 191
Estimating Return Distributionsp. 196
Tail Riskp. 203
Nonlinear Dependence between Asset Returnsp. 207
Credit Riskp. 212
Agency Ratings and Factor Models of Spread Riskp. 213
Rating Transitions and Defaultp. 217
Credit Instrumentsp. 218
Conceptual Approaches to Credit Riskp. 220
Recovery at Defaultp. 232
Portfolio Credit Modelsp. 232
The 2007-8 Credit-Liquidity Crisisp. 238
Transaction Costs and Liquidity Riskp. 241
Some Basic Terminologyp. 241
Measuring Transactions Costp. 246
Statistical Properties of Liquidityp. 261
Optimal Trading Strategies and Transaction Costsp. 266
Alternative Asset Classesp. 271
Nonsynchronous Pricing and Smoothed Returnsp. 271
Time-Varying Risk, Nonlinear Payoff, and Style Driftp. 284
Selection and Survivorship Biasesp. 291
Collectibles: Measuring Return and Risk with Infrequent and Error-Prone Observationsp. 295
Summaryp. 298
Performance Measurementp. 299
Return-Based Performance Measurementp. 299
Holdings-Based Performance Measurement and Attributionp. 303
Volatility Forecast Evaluationp. 309
Value-at-Risk Hit Ratesp. 316
Forecast and Realized Return Densitiesp. 317
Conclusionp. 319
Some Key Messagesp. 319
Questions for Future Researchp. 320
Referencesp. 323
Indexp. 345
Table of Contents provided by Publisher. All Rights Reserved.

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