Rengarajan holds a Master of Financial Engineering - University of
California, Berkeley and he works in the investment management
industry and specializes in providing economic and investment outlook
and strategy for global equity and government bond markets. He has an
educational background in financial engineering, business, and
engineering, and professional interests include business,
finance, economics, technology and related areas.
Author(s): Dale Gray & Samuel W.
Financial Risk Analysis by Dale Gray and Samuel Malone puts together
an integrated framework for measuring analyzing and managing
financial risk by weaving together traditional macroeconomic models
with models in mainstream finance.
The authors start with an overview of finance, macro economics, and risk concepts. The books lays a foundation for a unified framework by describing the differences between finance and macro economics on the treatment of concepts including uncertainty and risk.
In the context of macro financial risk, the authors highlight the need for incorporating balance sheets with risk, default and risk exposures. Since asset pricing and contingent claims are the missing components in macro models, the book emphasizes the importance of incorporating default and risk exposures in balance sheets.
The book highlights aspects including auto regression in economics versus random walk in finance, and briefly introduces relating finance models and risk analytics to macroeconomic models, specifically asset price processes with a threshold/barrier.
A brief but effective primer on macroeconomic models touches upon some of the widely used models including the ISLM model of close economy, open economy mundell fleming model and DGSE macro models.
Similarly there are primer chapters in introducing risk modeling concepts from a financial standpoint. There is a good introduction to stochcastic processes, Ito's lemma, asset pricing, and option pricing.
The authors further go in depth into concepts of balance sheet, implicit options and contingent claims analysis in the context of uncertain assets and probability of default on debt. Aspects of analyzing debt and equity as contingent claims including measuring asset values and volatility, measuring estimating implied asset value and asset volatility, and extensions of the contingent claims analysis are explained.
Part II of the book lays out the macrofinancial modeling framework and the key concept of an interlinked sector balance sheet. The concept of contingent claims balance sheet is explained in the context of economic sectors including linkages in a single financial sector framework and integrated value and risk transmission between sectors.
The book takes a closer look at issues in sovereign contingent claims analysis of balance sheets including calculating implied asset volatility, sovereign risk neutral and estimation of actual default probability, and estimating the spread on foreign and local currency debt. The book compares the time series methods in finance and compares it with interest rate models based on monetary policy and rates in Economics.
Risk indicators for individual banks and financial institutions, time series financial system risk indicators, using Merton model for capital adequacy estimation, factor models to assess key drivers of systemic risk, and multi factor risk analysis are covered in the discussion on financial sector risk and stability analysis.
Linking macro financial & macro economic frameworks is the theme of Part III. This looks at sovereign reserve, debt, and wealth management from a macro financial perspective. Several issues including reserve adequacy and asset allocation, constructing contingent claim balance sheet for national economy, macro financial framework relation to accounting balance sheet and flow of funds, economy wide macro contingent claims balance sheet and risk exposure, link between contingent claim analysis balance sheet, and risk exposure are examined.
Specifically, this section discusses how financial frameworks are linked to macro economic models by adding risk analytics to the spectrum of macroeconomic models, handling default risk, and the linking of financial models to DGSE and other macroeconomic models.
Crises and distress in Economics (Part IV) touches upon aspects of macro economic models versus crisis models. The section highlights some recent financial crisis and non-linearity inherent in modeling such crises. Volatility leverage effect, feedback between forward rate and domestic interest rate on local currency debt, local currency debt issuances and local currency spreads are examined in the context of financial crisis and destabilization. The section provides case studies of the Thai and Brazilian crises.
The final part of the book deals with various applications and analytical issues with the macrofinancial model. Types of global shocks and interaction with macrofinancial models, international financial system and crisis prevention are treated in the context of international shocks, risk transmission and crisis prevention.
Macro risk management looks at ways to mitigate, control and transfer risks including management of guarantees, long term risk management and policy change. The integrated framework for corporate and sovereign risk also finds application in capital structure arbitrage.
Macro Financial Risk Analysis is a great step towards integrating many of the models and concepts that exists side by side in economics and finance. The book is well recommended for a broad audience including finance professionals as well as policy makers in understanding and quantifying risks in the broader financial system as well as in institutions.