By Linda Allen
A step by step, actual global consultant to using worth in danger (VaR) types, this article applies the VaR method of the dimension of marketplace probability, credits hazard and operational possibility. The booklet describes and evaluations proprietary versions, illustrating them with sensible examples drawn from real case reports. Explaining the good judgment in the back of the economics and information, this technically refined but intuitive textual content might be an important source for all readers working in a global of probability. Applies the price in danger method of marketplace, credits, and operational chance size. Illustrates types with real-world case stories. positive aspects assurance of BIS financial institution capital specifications.
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Additional info for Understanding Market, Credit, and Operational Risk: The Value at Risk Approach
The estimation error and estimation lag is a central issue in risk measurement, as we shall see in this chapter. This last example illustrates the challenge of modern dynamic risk measurement. The most important task of the risk manager is to raise a “red flag,” a warning signal that volatility is expected to be high in the near future. The resulting action given this information may vary from one firm to another, as a function of strategy, culture, appetite for risk, and so on, and could be a matter of great debate.
Asset concentration increases portfolio volatility. • Well-balanced (equally weighted) portfolios benefit the most from the diversification effect. • Lower correlation reduces portfolio volatility. • Systematic risk is the most important determinant of the volatility of well-diversified portfolios. • Assets’ idiosyncratic volatility gets diversified away. 3 Diversification: Words of caution – the case of long-term capital management (LTCM) Risk diversification is very powerful and motivates much financial activity.
If this were the case we would 28 UNDERSTANDING MARKET, CREDIT, AND OPERATIONAL RISK have obtained a “mixture of normals” with varying means, that would appear to be, unconditionally, fat tailed. Is this a likely explanation for the observed fat tails in the data? The answer is negative. The belief in efficient markets implies that asset prices reflect all commonly available information. If participants in the marketplace know that prices are due to rise over the next day, prices would have already risen today as traders would have traded on this information.