Journal of Risk

Philippe Jorion

University of California at Irvine

This issue of the Journal of Risk contains a number of useful papers that reflect the latest developments in financial risk management. The first two papers deal with market risk alone. The next two deal with the intersection of credit and market risk.

"Estimation risk in financial risk management" is an important paper by Christoffersen and Gonçalves. The paper analyzes the problem of "estimation risk" in risk measures. This is an important issue because VAR measures are often presented as very precise numbers, which is not the case. The paper proposes a bootstrapping approach to estimate confidence intervals for VAR. Among a number of interesting results, it reports that there is much more estimation error in expected shortfall than value-at-risk measures.

The second paper is "Evolving yield curves in the real-world measures: a semiparametric approach" by Rebonato et al. The authors present a practical method for describing the evolution of yield curves over long periods. The choice of the model very much depends on the horizon of analysis. For VAR measures, for instance, which are of a short-term nature, volatilities dominate trends. As a result, using a full covariance matrix or some principal component simplification is adequate. Over long horizons, trends and autocorrelation are important. In addition, the shape of the yield curve needs to stay reasonably smooth. The paper presents a simple method that satisfies the shape and autocorrelation requirements for long-horizon forecasting.

Next is "Risk measurement with integrated market and credit portfolio models", by Grundke. The paper extends standard portfolio credit risk models that only account for transition and recovery risk to other types of risk. In particular, this paper takes into account interest rate risk and credit spread risk. The paper provides a realistic framework for assessing the benefit from integration of market and credit risk. It also analyzes various extensions of the basic model to correlated recovery rates and non-normal asset distributions.

Finally, in "The effects of jump risks associated with the default rate on credit spreads", Ahn, Kang and Kim extend the literature on "hybrid default models" for corporate bonds, where the hazard rate depends explicitly on the value process for the firm (or a market index) and the short interest rate, to the case where the firm value follows a jump-diffusion. The authors derive analytical solutions for the credit spread with jumps and show by numerical examples that the results differ from the usual diffusion process.

The mission of The Journal of Risk is to further our understanding of risk management. Contributions to the journal are welcome from academics, practitioners, and regulators in the field. With this in mind, authors are encouraged to submit full-length papers.