The purpose of this article is to gain a concrete understanding of the perception of Value at Risk, its strengths and weaknesses, and controversies related to its use in managing risk. Two articles will be used to help with the understanding of VaR, “An Irreverent Guide to Value at Risk,” by Barry Schachter and “Subjective Value-at-Risk,” by Glyn Hoyt. These articles will give us some background by describing VaR, understanding its limits, and its developing role in risk management.
Article 1 “An Irreverent Guide to Value at Risk”
Value at Risk has been called the “new science of risk management.” Around the world, organizations are sprinting to implement the new technology.
Because of its technical being, I would first like to give you 3 equal definitions of VaR given by the author.
1. A prediction of a given percentile, usually in the lower tail of the distribution of returns on a portfolio over some period; similar in principle to an estimate of the expected return on a portfolio, which is an estimate of the 50th percentile.
2. An estimate of the level of loss on a portfolio which is expected to be equaled or exceeded with a given, small probability.
3. A number invented by purveyors of panaceas for pecuniary peril intended to mislead senior management and regulators into a false confidence that market risk is adequately understood and controlled.
This is a statistical method used to calculate and specify the level of financial risk within a firm or investment portfolio over a limited time frame. The risk manager's task is to guarantee that risks are not taken beyond the level at which the firm can absorb the losses of a likely worst outcome. VaR is just a number created to give senior management false certa...
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...utcomes can further provide information on expected losses over a given time period. Stress testing is used as a supplement for VaR analysis. “Because VaR does not capture all relevant information about market risk, its best use is as a tool in the hands of a good risk manager.”
There is a reason to be skeptical of both its quality as a risk management instrument and its use in decision making.
Article 2 “Subjective Value-at-Risk”
Value-at-Risk is becoming extremely popular and is being bandied by pundits into measuring other risks such as credit and operational risk, and many believe that all risks of a company should be computed with a single risk measure. The author believes that if this were so there would be a lot of backlash due to VaR being controversial and that it still may be ineffective for analyzing these other risks as well as market risk.
Similar to what the article states, we have seen that risk is something that can go wrong, which we are unaware until a crisis happens. Many people tend to ignore the short tails of distribution saying they don't matter because there's a low possibility that it will occur. Think back to one such “perfect storm” that happened back in ...
It is used to measure the position of a firm in relation to its relative market share as well as its market growth. Based on this the situation where in all of the given four divisions of the firm are at different levels of performance can be evaluated in order to formulate a 5 year strategy plan. This can help in the creation of a portfolio where in returns are optimized by re investing in growth oriented sectors and divesting out of the sectors that are saturated and loss making for the firm.
The Group is exposed to a various financial risk which mainly includes liquidity risk, market risk, credit risk and cash flow risk. BDEV manages these risk by maintaining
Obviously, financial establishments can endure breathtaking misfortunes notwithstanding when their risk management is top notch. They are, all things considered, in the matter of going out on a limb. At the point when risk management fails, be that as it may, it is in one of the many fundamental ways, almost every one of them exemplified in the present emergency. In some cases, the issue lies with the information or measures that risk directors depend on. At times it identifies with how they recognize and impart the risks an organization is presented to. Financial risk management is difficult to get right in the best of times.
Risks are everywhere, however that does not mean one has to resort to accepting all levels of risk in the world. Risk is identifiable and as such can be mitigated down to a level where an individual is comfortable with or at the least tolerant of the risk. The stock market requires the use of an individual or business investor’s money and therefore involves considerable amounts of risk. Those who are averse to risk, yet can see the benefits of investing, must due their due diligence prior to investing in a stock that may be considered risky. By using beta and the security market line as tools to identify risk in the market, investors are able to mitigate risky decisions and build a comfortable portfolio that
...res risk sensitivity of the security to the market, and Alpha (α), which is the average, unexplained return (that is, return not explained by the market). (Weston et al, 2004).
Managers within any company can use this measure in order to obtain any crucial information they may need when making crucial decisions. When broken up EVA can simply be defined as an estimate of the amount by which earnings exceed or fall short of the required lowest rate of return that shareholders could receive by investing in the company. The main aim of any company should be to maximise the wealth of their shareholders, and as put forward by Stern-Stewart, EVA should be an aid to managers of company’s striving for this common target. The value of a company can also be easily judged with the aid of EVA by analysing the extent to which shareholders expect earnings to exceed or fall short of the total cost of capital. EVA takes into account the full cost of operating costs and capital costs including the full cost of equity.
This report seeks to give an in-depth analysis of the article written by Marris et al. (1998) on risk perception research and inquire the substantiality of the authors’ conclusions.
The author begins the article by defining the concept of modern portfolio theory (MPT). Modern portfolio theory can be defined as a theory on how investors can have optimal portfolios that generate the heights expected return based on a given level of risk. In other words, it is possible to build efficient frontier of optimal portfolios that generate maximum expected return at a given level of risk. The article presents the optimization process in the theory by its inputs and outputs. The first inputs is the expected returns for each security, which can be estimated using historical returns. The second input is the covariance matrix that includes the correlation coefficient, the standard deviation, and the variance of each security. The last input is the constraints in the selection of portfolio such as the turnover of the portfolio or liquidity. On the other hand, the optimization process has to outputs. The first is the efficient frontiers that represent the risk-return trade-off portfolios. The second output is the choice of portfolio that has the risk and return optimization for the investor.
On the other hand, it is also been concluded that using variance ratio tests, long horizon stock market returns can be predicted.... ... middle of paper ... ...(2008) “A Comprehensive Look at The Empirical Performance of Equity Premium Prediction”, The Review of Financial Studies, Vol. 21, No. 2 -. 4, pp. 58-78.
They use Digital Risk Assessment which is more accurate and can be utilized to find out major market risks.
It is a distance between a point P and distribution D and it measures number of standard deviations from point P to mean D.
As has been discussed before, risk identification plays an important part in the risk such as unique, subjective, complex and uncertainly. There are no two identical leaves in the world; similar, there are no two exactly the same risk either. Hence the best risk manger could not identify risk completely. Besides, risk identification assessment is done by risk analysts. As the different level of risk management knowledge, practical experience and other aspects between individuals, the result of risk identification may be difference. Furthermore, the process of identifying risk is still risky. Once risks have been identified, corporations have to take actions on limiting risky actions to reduce the frequency and severity of risky. They have to think about any lost profit from limiting distribution of risky action. So reducing risk identification risk is one of assessments in the risk
Specialists and analysts have developed a polemic on which instrument is best fit for measuring shareholder value. These indicators can be split into two groups: