...Initially, the VaR has been anticipating to quantify the available risks in derivatives markets, but it has grown widely and it has now been applied in measuring all kinds of risks, primarily credit and market risks. It also developed from a tool that quantifies risk to a tool that is applied in active risk management. Today VaR has shifted beyond application in financial institutions. In the beginning, companies with largely exposed to financial markets used other kinds of activities before spreading to other businesses. Today, an ever-growing numbers of individual businesses apply and appreciate VaR as an effective tool for quantifying financial risksKrause (2003). This trend is evidently aided by the fact that non-specialists easily understand VaR. The risks of the prevalent use of VaR are an overdependence on the results it gives, misconception, and even abuse. It is as a result that, essential individuals using VaR understand its problems and limitations. In this paper, I will explore in depth these constraints, which unluckily do not mark prominently. To begin with, the VaR estimate is founded on precedent data, that is, it uses past distribution of effects of the investment. However, to calculate the peril of an investment, it is of no concern how big this risk has been in the earlier period, but fairly on how much exposure there is within the existing period; therefore, the future distribution of outputs would be the appropriate to consider. As long as the division...
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...VAR as a risk management tool. VAR is one of the simple and widely used risk measures that attempt to summarise the total risk of the portfolio. Despite of its popularity within Financial Intuitions, Treasures and Fund Managers, there are frequent criticisms against its use which we will discuss in this part. One of the criticisms is that VAR focuses on the risks around the middle area of the distribution and completely ignores the tail portion which is associated with large losses. (Glasserman, Heidelberger & Shahabuddin, 2002, P239). So, the probability of the portfolio losing side has not been evaluated enough. For example, the interpretation of VAR number $904,617 calculated previously for the bank’s portfolio is that there is a 99% probability that the maximum loss will not exceed $904,617. This may not be the case if the 1% loss is of significant amount and of unpredictable nature. Measuring rare events such as Bank Robberies and Natural disasters are almost impossible. The use of historical data in such context is not sufficient enough predict the future which can lead to excessive risk taking or not hedging property. It may turn out to be like an airbag in a car that works all other times but the time of an accident. Another criticism is regarding the Subadditivety. The sum of VAR of two portfolios is actually larger than the sum of 2 VARs. The end result should be either equal or lesser than the sum because diversification actually reduces the risk. This violates...
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...Thesis for the Degree of Master of...? INCORPORATING LIQUIDITY RISK INTO VAR MODEL TO IMPROVE RISK MANAGEMENT AND APPLYING THE LIQUIDITY ADJUSTED VALUE AT RISK MODEL ON VIETNAMESE STOCK MARKET Student: Ten truong: Ten khoa hoc: September, 2012 INCORPORATING LIQUIDITY RISK INTO VAR MODEL TO IMPROVE RISK MANAGEMENT AND APPLYING THE LIQUIDITY ADJUSTED VALUE AT RISK MODEL ON VIETNAMESE STOCK MARKET by student Avised by Ten giao su Submitted to Ten khoa of Ten truong in the partial fulfilment of the requirements for the degree of Master of ...? Dissertation Committee ...Ten thanh vien hoi dong ABSTRACT In this paper, based on Bangia et. al (1999) Liquidity Adjusted Value at Risk, an explanation and demonstration for the importance of integrate liquidity risk component into Value at Risk Model are presented. The component is considered to be resulted from the exogenous liquidity risk, indeed, the bid-ask spread of a stock or a portfolio. This research is conducted from the analysis of an estimation of Value at Risk (VaR) and Liquidity adjusted Value at Risk for two portfolios containing stocks that are currently trading on Vietnamese Stock Market. After applying the Bangia Model to calculate, the backtesting will be executed to check the accuracy level of the results. The difference between the results of two portfolios, according to separate approaches will be the evidence to reach the conclusion of the research. Table of Contents List of...
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...draft: August 2007 Comments welcome The Anatomy of Value and Growth Stock Returns Eugene F. Fama and Kenneth R. French* Abstract We break average returns on value and growth portfolios into dividends and three sources of capital gain, (i) growth in book equity primarily due to earnings retention, (ii) convergence in price-tobook ratios (P/B) due to mean reversion in profitability and expected returns, and (iii) upward drift in P/B during 1927-2006. The capital gains of value stocks trace mostly to convergence: P/B rises as some value firms become more profitable and their stocks move to lower expected return groups. Growth in book equity is trivial to negative for value portfolios, but it is a large positive factor in the capital gains of growth stocks. For growth stocks, convergence is negative: P/B falls because growth firms do not always remain highly profitable with low expected stock returns. Relative to convergence, drift is a minor factor in average returns. Graduate School of Business, University of Chicago (Fama), and Amos Tuck School of Business, Dartmouth College (French). We are grateful for the comments of Jonathan Lewellen. * Value stocks (with low ratios of price to book value) have higher average returns than growth stocks (high price-to-book ratios). (See, for example, Rosenberg, Reid, and Lanstein 1985, Fama and French 1992.) Our goal is a better understanding of the sources of this value premium in returns. The one-period simple return on a stock...
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...Introduction to CreditMetrics™ The benchmark for understanding credit risk New York April 2, 1997 • • • A value-at-risk (VaR) framework applicable to all institutions worldwide that carry credit risk in the course of their business. A full portfolio view addressing credit event correlations which can identify the costs of over concentration and benefits of diversification in a mark-to-market framework. Results that drive: investment decisions, risk-mitigating actions, consistent risk-based credit limits, and rational risk-based capital allocations. J.P. Morgan Co-sponsors: Bank of America Bank of Montreal BZW Deutsche Morgan Grenfell KMV Corporation Swiss Bank Corporation Union Bank of Switzerland Table of Contents 1. Introduction to CreditMetrics 2. The case for a portfolio approach to credit risk 3. The challenges of estimating portfolio credit risk 4. An overview of CreditMetrics methodology 5. Practical applications 3 9 12 14 30 Introduction to CreditMetrics Copyright © 1997 J.P. Morgan & Co. Incorporated. All rights reserved. J.P. Morgan Securities, Inc., member SIPC. J.P. Morgan is the marketing name for J.P. Morgan & Co. Incorporated and its subsidiaries worldwide. CreditMetrics™, CreditManager™, FourFifteen™, and RiskMetrics™ are trademarks of J.P. Morgan in the United States and in other countries. They are written with the symbol ™ on their first occurance in the publication, and as CreditMetrics, CreditManager, FourFifteen or RiskMetrics thereafter...
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...Bank of India Occasional Papers Vol. 25, No. 1, 2 and 3, Summer, Monsoon and Winter 2004 Liquidity Adjustment in Value at Risk (VaR) Model: Evidence from the Indian Debt Market Sunando Roy* Conventional Value at Risk models are severely constrained while dealing with liquidity risk. This inevitably leads to an underestimation of overall risk and consequently misapplication of capital for the safety of financial institutions. Standard Value at Risk (VaR) model assumes that any quantity of securities can be traded without influencing market prices. In reality, most markets are less than perfectly liquid and many securities cannot be traded with ease in markets. This is especially true for emerging market economies where the process of financial sector reform and deepening is currently taking place. Despite episodic evidences of liquidity crisis in the Indian financial markets, risks associated with market illiquidity have not been effectively incorporated into the VaR models. In the face of sudden and persisting off-market prices of some of the securities in their portfolio, the Indian financial organizations often find it difficult to offload these securities without booking significant trading losses. As a consequence, several securities exhibit very low levels of turnover in the secondary segment of the debt market. Also, in most cases, measures of market risk fail to capture the costs of carrying illiquid assets in their portfolio. This becomes a constraining factor for market...
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...Credit risk economic capital: Measure, Attribution of portfolio diversification benefit, Allocation key to portfolio components. Emmanuel Noblet Executive Summary Recent years have witnessed significant advances in the design, calibration and implementation of credit risk portfolio models. [BANK X] currently uses Moody’s KMV (Kealhofer, McQuown and Vasicek) Portfolio Manager ([PM]). Models enrich management’s ability to make informed decisions to identify concentrations of risk and opportunities for diversification within a disciplined and objective framework, and thus offer a more sophisticated, less arbitrary alternative to traditional lending limit controls. It is thus essential to make sure models are in line with management’s goals and vice versa to make sure management takes some perspective to understand how the central measure it returns, namely credit risk economic capital ([EC]), is constructed and what it means. This memo aims at explaining: A) how credit risk is measured; B) what the implications of attributing or not portfolio diversification effects are; C) how this portfolio measure is then allocated back to the portfolio components. A - How is credit risk measured? Back to basics, a credit risk portfolio model is a function that maps a set of facility-level characteristics and market-level parameters to a distribution of potential portfolio credit losses. This definition is better known as Value-at-Risk ([VaR]). The concept of VaR has become the standard...
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...Swarna Ramineni sr3121 Answer 1) Value at risk: It is a statistical technique to measure the amount of potential loss, the probability of the loss, and the time frame. Value at risk is used by risk managers in order to measure and control the level of risk which the firm undertakes. The risk manager's job is to ensure that risks are not taken beyond the level at which the firm can absorb the losses of a probable worst outcome. For example, a financial firm may determine that it has a 5% one month value at risk of $100 million. This means that there is a 5% chance that the firm could lose more than $100 million in any given month. Conditional value at risk on the other hand is an extension of value at risk. It is derived by taking weighted average between the value at risk and losses exceeding the value at risk. The VaR model does allow managers to limit the likelihood of incurring losses caused by certain types of risk - but not all risks. The problem with relying solely on the VaR model is that the scope of risk assessed is limited, since the tail end of the distribution of loss is not typically assessed. Therefore, if losses are incurred, the amount of the losses will be substantial in value. Conditional value at risk does a better job at assessing the tail VaR and hence is a very useful tool for risk managers. Answer 2) NAV as of Nov 1, 2013 is $169,018 Gross Leverage is 1.744 and Net Leverage is 0.7017 The latest 1 month values are as below Ann Cash Rate 0.2% ...
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...CEO Toolkit n GLOBAL CEO n January 2003 A CEO’s guide to value at risk models Ravi Madapati* Value at Risk (VaR) models are being used extensively in the world of risk management. VaR provides an upper bound on the potential loss due to adverse market fluctuations. VaR can be used to estimate risk in the case of various financial instruments including bonds, equities and derivatives. S ince the past decade or so no other tool in financial risk management has been heard about as much as Value at Risk (VaR) modeling. VaR has rapidly become the industry standard for measuring and reporting market risk in trading portfolios of banks and other trading institutions. VaR provides an upper bound on the potential loss due to adverse market fluctuations. Any VaR number has to specify which portfolio is being considered (e.g., Equity derivatives book), the confidence level (e.g., 97.5%) and the holding period (e.g., 10 days). VaR objectively tries to combine the sensitivity of the portfolio to market changes and the probability of a given market change. VaR has been adopted by the Basel Committee to set the standard for the minimum amount of capital to be held against the market risks. VaR can be used to estimate risk in the case of various financial instruments including bonds, equities and derivatives. VaR can be used to communicate risk and to control risk by setting limits for frontline traders and operating managers. Pros and cons of using VaR...
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...it assist clients with reducing the appraised value of their property, which in turn reduces the amount of property taxes due. The organization is diversifying; it is going into third party collections, judgment recovery, and mortgage loans. This firm has made substantial errors in the past therefore to understand the cause and effect of those errors we will attempt to model their market and business behaviour. This model is an effort to estimate the expected results of alternative strategies and processes. Consumer expectations and other variables as well as technology, the internet, telecommunications and globalization have accelerated the pace of change, and shortened product lifecycles has contributed to this strategic plan. Technology has augmented the capability to amass information and respond to change immediately and analytically. It is also important for corporations to achieve and maintain their competitive advantages. Cash Infusion The cash infusion allocated to enhance the company and to manage is $40 million dollars. Following is the description of portfolio strategy and a portfolio of assets in relation to the investment of $40 million that will be used by O’Connor to maximize wealth: Portfolio Strategy To analyze diverse concerns such as introduction of an independent growth path to a high-risk business, capture of the portfolio strategic risk in an appropriate manner and measurement of value and risk at portfolio level, it is necessary to develop...
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...Wells Fargo Risk Management “Risk comes from not knowing what you’re doing.”—Warren Buffet 2014 Jovan Gonzalez University of Texas at San Antonio 2/11/2014 Wells Fargo Risk Management “Risk comes from not knowing what you’re doing.”—Warren Buffet 2014 Jovan Gonzalez University of Texas at San Antonio 2/11/2014 Overview When it comes to managing key risks that financial institutions face such as, credit risk, asset/liability interest rate and market risks, Wells Fargo Board of Directors (Board) and senior management are ultimately responsible for managing these risks. Along with the help of different committees such as, The Board’s Credit Committee, who manages the annual credit quality plan, lending policies, credit trends, and high risk portfolios and concentrations. The Finance Committee manages the company’s major financial risks such as, interest rate, and market/price risk with the help of the Corporate Asset/Liability Management Committee (ALCO), who meet periodically with each other. Although there are much more committees that are in charge of overseeing other risks, for the purpose of this paper I’m mainly focusing on credit risk, market risk, and interest rate risk. According to Wells Fargo’s annual report, each Board committee receives reports and information regarding risk issues directly from senior management, who meets directly with the CEO every week to discuss strategic risk issues at the operational level. Wells Fargo also has a Chief...
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...Marginal Risk Contributions Overview This chapter focuses on marginal risk contributions, to portfolio loss volatility or to portfolio capital, and compares them with absolute risk contributions. Marginal risk contributions serve essentially for risk-based pricing with an ‘ex ante’ view of risk decisions, while absolute risk contributions are the basis for the capital allocation system. Marginal risk contributions to capital are the correct references for risk-based pricing. Pricing based on marginal risk contributions charges to customers a mark-up equal to the risk contribution times the target return on capital. The mark-up guarantees that the return on capital for the entire portfolio will remain in line with the target return when adding new facilities. However, prices based on marginal risk contributions are lower than prices based on absolute risk contributions. This is a paradox, since the absolute risk contributions are the ones that sum to capital. In fact the new facility diversifies the risk of those existing facilities prior to the entrance of any new one. Therefore, adding a new facility results in a decline in all absolute risk contributions of existing facilities. Because of this decline, the overall return of the portfolio remains on target. However, the ex-ante measure of risk-based performance, on the marginal contribution and the ex-post measure, on the absolute contribution, differ for the same facility. The Marginal Risk Contributions ...
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...preset standards, in order to correct possible deviations and keep the intended strategy on track. --- Beliefs systems: the explicit set of organizational definitions that senior managers communicate formally and reinforce systematically to provide basic values, purpose and direction for the organization; --- Boundary Systems: they delineate the acceptable domain of activity for organisational participants. Unlike belief systems, they do not specify positive ideals. Rather, they establish limits, based on defined business risks, to opportunityseeking. --- Interactive Control Systems: they are the formal information systems that managers use to involve themselves regularly and personally in the decision activities of subordinates. They focus attention and force dialogue throughout the organisation. They provide frameworks, or agendas, for debate, and motivate information gathering outside of routine channels. (b) Belief systems are broad and inspirational in order to appeal to all organizational levels. Thus, they are not specific enough to be used as standards or as a basis for performance evaluation. Since they are highly inspirational and encourage the organization to unfocused search for new opportunities, the organization risks a dispersion of energy and resources. In order to balance the positive effects of belief systems, and focus organizational behaviour, top managers use boundary systems to define the acceptable domain for opportunity-seeking behaviour. Working together...
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...A portfolios risk plays a huge role in an investors expected returns which is why it is so important to not only be able to measure this risk but also to have some sort of control over it. There are many different risk measures that are available which are becoming much easier to perform with the technology these days. Some of the most common include the standard deviation, Beta, Alpha and the sharp ratio. Using the correlation and covariance can also be useful when it come to diversifying a portfolio and reducing risk. Another thing that should be considered is the number of securities within the portfolio because this has a large impact on diversifiable risk. 1)Risk measures -Why is it important to consider different risk measures? Although standard deviation may be one of the most common and widely used tool to measure risk it is very important that one considers different risk measures as well as the standard deviation when constructing a portfolio. One reason for this is that the standard deviation does not take into account the securities volatility in relation to the market. Other measurements for example Beta can be a good measurement of this volatility. Two other measurements that are very important are correlation and covariance which tell you wether the securities are positively or negatively related, or maybe even not related at all. This can help investors further diversify their portfolio and reduce overall risk. The sharp ratio is also a very useful...
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...money. Besides, the financial markets are fluctuating. Hence, we decide to run a portfolio in a bid to add value to the wealth of individuals. Objectives In order to add value to the wealth of individuals, we will set a target of expected rate of return which would be equal to or above 8% at a certain level of risk. In this portfolio, we would consider the following assets in emerged areas: 1. Cash 2. Stocks 3. Bonds Methodology To pick the most suitable stocks for our portfolio, top-down approach will be used. That is, we will firstly analyze the economy of the country, the relative industry and the company situation accordingly, in order to choose the most suitable stocks. Hong Kong and The USA are the most preferred country for our portfolio. As Hong Kong is the area we most familiar, and The US is the country with the strongest economy recently, choosing these areas’ stocks would help reducing our exchange rate risk. Estimating volatility would be used to determine the risk. It can be calculated by: For our portfolio, United States Government Bonds (10 years) would be chosen. Bond yield would be used as the risk free rate. We would take Beta (β) of each individual stocks into the weighting of the portfolio, so that the volatility would be more localized and accurate. More different models like CAPM to find out relationship of expected return and risk, and other models will also be included for our...
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