Macro Financial Risk Analysis Reviewed by Manoj Rengarajan of Bookpleasures.com
- By Manoj Rengarajan
- Published May 30, 2009
- Business
Manoj Rengarajan
Reviewer Manoj
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.
Malone
Publisher: Wiley
ISBN: 978-0-470-05831-2
Click Here To Purchase Macrofinancial Risk Analysis (The Wiley Finance Series)
Macro
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.