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Common Risk Measures Descriptions and Comparisons. William C. Wojciechowski VIGRE Computational Finance Seminar Rice University October 15, 2003. Defining Risk. What is risk? How is risk measured? Types of risk – market, credit, liquidity, etc. Finance is one area of risk management

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common risk measures descriptions and comparisons

Common Risk MeasuresDescriptions and Comparisons

William C. Wojciechowski

VIGRE Computational Finance Seminar

Rice University

October 15, 2003

defining risk
Defining Risk
  • What is risk?
  • How is risk measured?
  • Types of risk – market, credit, liquidity, etc.
  • Finance is one area of risk management
  • Against The Gods: The Remarkable Story of Risk - Peter L. Bernstein
defining risk1
Defining Risk
  • Risk - chance that an investment’s return will be less than expected.
  • Market Risk – loss in value due to decline in price
  • Event Risk – catastrophic actions cause decrease in value
  • Liquidity Risk – lose value by not being able to transact
measuring risk
Measuring Risk
  • X - a random variable representing the value of an investment at some future time t
  • Scalar, such as volatility of X?
  • Vector, such as a value and probability?
  • Consider the whole distribution of X?
common risk measures
Common Risk Measures
  • Dispersion Measures
common risk measures1
Common Risk Measures
  • More dispersion does NOT equal more risk
  • Normal mixture model with possible large win
  • Normal model without possible large win
common risk measures2
Common Risk Measures
  • More dispersion does NOT equal more risk
common risk measures3
Common Risk Measures
  • More dispersion does not equal larger positive returns
common risk measures4
Common Risk Measures
  • Dispersion below a target
  • Fishburn family
common risk measures5
Common Risk Measures
  • VAR (Value at Risk) Measures
common risk measures6
Common Risk Measures
  • Accumulate VAR (AVAR)
common risk measures7
Common Risk Measures
  • Simulations
    • Generate random return streams X and Y
    • For each risk measure, calculate the risk of X and Y
    • Count the number of times the risk measure makes the correct decision
simulations
Simulations
  • Possibility of large gain
simulations1
Simulations
  • Moderate chance of large loss
simulations2
Simulations
  • Small chance of catastrophic loss
conclusions
Conclusions
  • There are many possible measures of risk
  • Appears none of the common risk measures universally applies to all situations
  • Research opportunities are abundant
reference
Reference
  • Guy Kaplanski and Yoram Kroll, “VAR risk measures vs traditional risk measures: an analysis and survey”, Journal of Risk, 4, Spring, 2002