BlackRock's Guide to Fixed-Income Risk Management

Bennett W. Golub is one of the original founders of BlackRock. During his 34-year career at BlackRock, Dr. Golub was a member of BlackRock’s Global Executive Committee, co-head of its Risk & Quantitative Analysis group and served as BlackRock’s Chief Risk Officer from 2009—2022. Additionally, he co-founded BlackRock Solutions. Currently, Dr. Golub serves as a Senior Advisor to BlackRock.

• Frequently Used Abbreviations xviiForeword xxiPreface xxiiiAcknowledgments xxxiSECTION I An Approach to Fixed-Income Investment Risk Management 1CHAPTER 1 An Investment Risk Management Paradigm 3Bennett W. Golub and Rick Flynn1.1 Introduction 31.2 Elements of Risk Management 41.3 BlackRock’s Investment and Risk Management Approach 61.4 Introduction to the BlackRock Investment Risk Management Paradigm 7CHAPTER 2 Parametric Approaches to Risk Management 11Bennett W. Golub and Leo M. Tilman2.1 Introduction 112.2 Measuring Interest Rate Exposure: Analytical Approaches 122.3 Measuring Interest Rate Exposure: Empirical Approaches 302.4 Measuring Yield Curve Exposure 342.5 Measuring and Managing Volatility Related Risks 402.6 Measuring Credit Risk 472.7 Measuring Mortgage-Related Risks 502.8 Measuring Impact of Time 52CHAPTER 3 Modeling Yield Curve Dynamics 59Bennett W. Golub and Leo M. Tilman3.1 Probability Distributions of Systematic Risk Factors 593.2 Principal Component Analysis: Theory and Applications 613.3 Probability Distributions of Interest Rate Shocks 75CHAPTER 4 Portfolio Risk: Estimation and Decomposition 81Amandeep Dhaliwal and Tom Booker4.1 Introduction 814.2 Portfolio Volatility and Factor Structure 834.3 Covariance Matrix Estimation 854.4 Ex Ante Risk and VaR Methodologies 934.5 Introduction to Risk Decomposition 1034.6 Alternative Approaches to Risk Decomposition 1044.7 Risk Decomposition Using CTR 1084.8 Risk Decomposition Through Time 1164.9 Risk Decomposition: Summary 119CHAPTER 5 Market-Driven Scenarios: An Approach for Plausible Scenario Construction 125Bennett W. Golub, David Greenberg, and Ronald Ratcliffe5.1 Introduction 1255.2 Implied Stress Testing Framework 1275.3 Developing Useful Scenarios 1345.4 A Market-Driven Scenario Example: Brexit 1365.5 Conclusion 142CHAPTER 6 A Framework to Quantify and Price Geopolitical Risks 145Catherine Kress, Carl Patchen, Ronald Ratcliffe, Eric Van Nostrand, and Kemin Yang6.1 Introduction 1456.2 Setting the Scene 1466.3 BlackRock’s Framework for Analyzing Geopolitical Risks 1496.4 Global Trade Deep Dive 1496.5 What Is Already Priced In? 1536.6 Taking Action 1566.7 Caveats and Cautions 159CHAPTER 7 Liquidity Risk Management 163Bennett W. Golub, Philip Sommer, Stefano Pasquali, Michael Huang, Kristen Walters, and Nikki Azznara7.1 Introduction 1637.2 A Brief History of Liquidity Risk Management 1647.3 A Fund Liquidity Risk Framework 1667.4 Asset Liquidity 1667.5 Redemption Risk 1697.6 Liquidity Stress Testing 1707.7 Extraordinary Measures 1717.8 Fixed-Income Data Availability Limitations 1717.9 Conclusion 181CHAPTER 8 Using Portfolio Optimization Techniques to Manage Risk 183Alex Ulitsky, Bennett W. Golub, Leo M. Tilman, and Jack Hattem8.1 Risk Measurement Versus Risk Management 1838.2 Typical Fixed-Income Hedges 1858.3 Parametric Hedging Techniques 1878.4 Generalized Approach to Hedging 1898.5 Advanced Portfolio Optimization and Risk Management Techniques 207CHAPTER 9 Risk Governance 219Bennett W. Golub9.1 Introduction 2199.2 Risk Scan Standard Framework 2199.3 Risk and Performance Target (RPT) Framework 2219.4 Governance 223CHAPTER 10 Risk-Return Awareness and Behavioral Finance 225Emily Haisley and Nicky Lai10.1 Introduction 22510.2 Portfolio and Risk Manager Partnership 22610.3 Behavioral Risk Management for Fixed Income 22710.4 Decision-Making Analytics 22910.5 Investment Process 23510.6 Conclusion 241CHAPTER 11 Performance Attribution 243Reade Ryan and Carol Yu11.1 Introduction 24311.2 Brinson Attribution and Beyond 24411.3 Factor-Based Attribution 25211.4 Equity Fundamental Factor-Based Attribution 256CHAPTER 12 Performance Analysis 259Mark Paltrowitz, Mark Temple-Jones, Viola Dunne, and Christopher Calingo12.1 Introduction 25912.2 Performance Governance 26012.3 Performance Metrics 26012.4 Conclusion 266CHAPTER 13 Evolving the Risk Management Paradigm 267Bennett W. Golub, Michael Huang, and Joe Buehlmeyer13.1 Introduction 26713.2 Traditional Buy-Side Risk Management Framework 26813.3 Evolving the IRMP: In Pursuit of Investment Risk Management at Scale 26813.4 Risk Governance 27013.5 Supporting Risk Governance Through Technology 27013.6 Implementing a Risk Governance Framework Through Aladdin 27113.7 Aladdin's Risk Radar Example 27113.8 Conclusion 276SECTION II Fixed-Income Risk Management—Then and Now 277CHAPTER 14 The Modernization of the Bond Market 279Daniel Veiner, Stephen Laipply, Carolyn Weinberg, Samara Cohen, Vasiliki Pachatouridi, and Hui Sien Koay14.1 Charting the Evolution of Bond Markets 27914.2 The Development of an Index-Based Ecosystem 28514.3 Implications for Investing, Portfolio Management, and Risk Management 28914.4 The Future State of Portfolio Construction 29014.5 Conclusion 290CHAPTER 15 The LIBOR Transition 293Jack Hattem15.1 Introduction 29315.2 Implications to Portfolio and Risk Management 29515.3 Shift from LIBOR to SOFR 29515.4 Risk Management Impact and Coordination 29715.5 Reflections on a Benchmark Reforms 298CHAPTER 16 Derivatives Reform: The Rise of Swap Execution Facilities and Central Counterparties 301Eileen Kiely and Jack Hattem16.1 The Call for Change: 2008 Global Financial Crisis 30116.2 The Value of Derivatives in Fixed-Income Portfolios 30216.3 Trading Fixed-Income Derivatives: The Rise of SEFs 30416.4 Clearing Fixed-Income Derivatives: The Rise of CCPs 30516.5 CCP Risk Mitigation Techniques 30616.6 The Call for Change: Market Participants Ask for Stronger CCPs 30816.7 Conclusion 311SECTION III Lessons from the Credit Crisis and Coronavirus Pandemic 313CHAPTER 17 Risk Management Lessons Worth Remembering from the Credit Crisis of 2007–2009 315Bennett W. Golub and Conan Crum17.1 Introduction 31517.2 The Paramount Importance of Liquidity 31617.3 Investors in Securitized Products Need to Look Past the Data to the Underlying Behavior of the Assets 32617.4 Certification Is Useless During Systemic Events 33117.5 Market Risk Can Change Dramatically 33217.6 The Changing Nature of Market Risk 33617.7 By the Time a Crisis Strikes, It’s Too Late to Start Preparing 33717.8 Conclusion 338CHAPTER 18 Reflections on Buy-Side Risk Management After (or Between) the Storms 341Bennett W. Golub and Conan Crum18.1 Introduction 34118.2 Risk Management Requires Institutional Buy-In 34118.3 The Alignment and Management of Institutional Interests 34218.4 Getting Risk Takers to Think Like Risk Managers 34518.5 Independent Risk Management Organizations 34518.6 Clearly Define Fiduciary Obligations 34718.7 Bottom-Up Risk Management 34818.8 Risk Models Require Constant Vigilance 34918.9 Risk Management Does Not Mean Risk Avoidance 350CHAPTER 19 Lessons Worth Considering from the COVID-19 Crisis 353Barbara Novick, Joanna Cound, Kate Fulton, and Winnie Pun19.1 Introduction 35319.2 Background 35419.3 Core Principles Underpinning Recommendations 35419.4 March 2020: Capital Markets Highlights and Official Sector Intervention 35519.5 COVID-19 Lessons: What Worked and What Needs to be Addressed 35719.6 Recommendations to Enhance the Resilience of Capital Markets 36319.7 Concerns with Macroprudential Controls 36819.8 Conclusion 36919.9 Postscript 369Notes 370Bibliography 373About the Website 383About the Editor 385About the Contributors 387Index 391