Study Programmes 2015-2016
FINA0064-1  
Financial Risk Modeling
Duration :
30h Th
Number of credits :
Master in economics : general (120 ECTS)5
Master in business engineering (120 ECTS)5
Master in business engineering (120 ECTS)5
Lecturer :
Laurent Bodson, Marie Lambert
Language(s) of instruction :
English language
Organisation and examination :
Teaching in the second semester
Units courses prerequisite and corequisite :
Prerequisite or corequisite units are presented within each program
Course contents :
The course of Financial Risk Modeling introduces students to a set of techniques for measuring risks in financial portfolios. The course is not about risk management but risk measurement and modeling.
 
The course is divided into two main parts. The first part focuses on measuring market risks. The second part extends the notion of financial risk to other types of risks (e.g. credit risk, liquidity risk or operational risk) by covering some regulatory requirements imposed to European financial institutions.
 
Part I: Modeling market risk (M. Lambert)
As initially emphasized by Markowitz, the two relevant characteristics of an asset portfolio are its expected return and the dispersion of possible returns around the expected return, i.e. the standard deviation of returns. Presuming risk aversion, rational investors will choose to hold efficient portfolios, i.e. those that maximize the expected return for a given degree of risk or, alternatively, minimize risk for a given level of expected return.
 
Modules 1 and 2 on "How to model market risk" reviews Modern Portfolio Theory by emphasizing the limits of a Markowitz analysis. We first focus on the challenge in estimating the input parameters (Module 1) and the need for higher-moment measures (i.e. beyond the mean-variance) (Module 2).
 
Keywords: shrinkage estimators, constant correlation, robust variance-covariance matrix, VaR, Expected Shortfall, Cornish Fisher VaR, Higher-moments and co-moments ((co-)skewness, (co-)kurtosis).
 
Module 3 on "How to achieve risk diversification" challenges the hypothesis of the value-weighted portfolio as a proxy for the efficient portfolios. It introduces students to fundamental indexing and smart beta strategies.
 
Keywords: smart beta strategies, equally-weighted portfolio versus value weighted portfolio, risk parity, maximum diversification, diversity.
 
Part II: Regulatory risks (L. Bodson)
 
The repeated and global financial crises have forced regulators to restructure fundamentally the risk regulation in the financial sector. Nowadays, all financial institutions need to comply with specific regulatory requirements in addition to their self-discipline.
 
This second part of the course addresses three major regulations of the European financial regulatory landscape:
Module 1 - UCITS Directives: these Directives have significantly impacted the evolution of the European investment fund industry by imposing more intensive and intrusive supervision guidelines.
 
Module 2 - Solvency Directives: these regulatory rules govern the European insurance business defining quantitative (such as the amount of solvency capital), governance and transparency requirements.
 
Module 3 - Basle Accords: these agreements refer to the European banking sector supervision and they impose quantitative (such as loss reserves to hold), governance and transparency requirements.
Learning outcomes of the course :
Overall during this course, students will be able to:
- strengthen their knowledge and understanding of basic management disciplines in order to use them to perform a rigorous analysis of a management situation and provide pertinent solutions;
- gain knowledge and understanding of financial engineering and be able to mobilize them in order to solve concrete management problems or cases;
- develop their ability to speak in English; 
- strengthen their capacity to research autonomously and methodically the information needed to solve a complex, transversal management problem, to perform a rigorous analysis of it and to suggest pertinent solutions;
- develop their understanding and ability of using modelization methods when seeking a solution for a concrete management problem;
- developed their capacity to design concrete solutions to a management problem, integrating a dimension of technology, innovation or production;
- developed team work abilities;
- developed their critical sense (arguing);
- strengthened their capacity for creative conception of solutions;
- strengthened their professional capacity for oral communication.
 
 
Specific skills and competencies are trained during this course.

At the end of part I, students will be able to:
- measure robust variance-covariance matrices for asset allocation and risk measurement;
- measure the potential for diversification of a portfolio taking into account its volatility, downside risk and extreme risk;
- measure the VaR of a stock portfolio using GARCH model;
- define alternative efficient portfolio specification (using heuristic and statistic methods) and test their outperformance over the common commercial (value-weighted) indexes.

At the end of part II, students will be able to:
- understand the major goals of the UCITS V Directive;
- measure the Global Exposure of a fund using the Commitment Approach and the Value-at-Risk Approach;
- measure an OTC Counterparty Risk Exposure;
- understand the major objectives of the Solvency II Directive;
- measure the solvency capital requirements of an insurance company;
- understand the objectives of the Basle III Accords;
- measure the minimum capital requirements of a bank.
Prerequisite knowledge and skills :
Students attending this course are expected to have a good background in investment and portfolio management and have a good understanding of asset pricing models.
Planned learning activities and teaching methods :
The course is lecture-style with active discussions about practical examples.
 
Each theoretical session will be followed by a "computer lab" session for applying the studied concepts on practical case-studies.
 
The course has been developed to effectively combine each theoretical session with real-business case-studies.
For each part of the course, students will work on a group project. They are invited to work in groups of 2 or 3 students.
Mode of delivery (face-to-face ; distance-learning) :
The course is face-to-face lecture and group-meeting style. 
Recommended or required readings :
The recommended textbook for Part I is:
Market Risk Analysis: Practical Financial Econometrics by Carol Alexander ISBN-10: 0470998016 | ISBN-13: 978-0470998014 | Edition: Volume II
 
 
The recommended readings for Part II are the (technical) regulatory documents describing the UCITS, Solvency and Basle Accords requirements.
 
In order to be up-to-date within this fast-moving research area, the course is mostly based on scientific articles and regulatory documents whose references can be found into the slide lectures.
Assessment methods and criteria :
The final grade will be determined by :
 
1. Case studies and group projects: 30%
2. Active class participation (attending class and actively discussing/applying material in class) - individual grade: 30%
3. Individual Oral exam: 40%
Work placement(s) :
none
Organizational remarks :
Attendance to lectures and computer labs are mandatory and will be controlled and graded (individual class participation).
Absences from exams are allowed only for justified medical reasons. Unexcused absences from exams will lead to a zero score in the calculation of the final grade.
Contacts :
Part I: Modeling market risk Prof. Marie Lambert - email: marie.lambert@ulg.ac.be 
Boris Fays - teaching assistant - boris.fays@ulg.ac.be
N1 (office 109): Please schedule an appointment by email!
Part II: Regulatory risks
Affiliate Prof. Laurent Bodson - email: Laurent.Bodson@ulg.ac.be
 
Items online :
online notes
The core materials for the course consist of the required textbook readings. Lecture notes will be available on the course web page (on lol@). Other items such as problem sets will also be available on the course web page. Some additional readings on materials related to the course over the term may be provided throughout the course via the course web page.