BlackRock's Guide to Fixed-Income Risk Management

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