Manual An Introduction to Value-at-Risk (Securities Institute)

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Register Today. Hear from past students about their training experience at NYIF and see where they are today. May Apr May 4. Feb Mar 2. Take the case of Union Bank of Switzerland. In the second half of the s the bank was establishing risk-management systems to aggregate risks across all its securities-trading operations. The bank decided, at the top level, that it was more important to let the traders make money than to disrupt what they were doing in order to make the change.

As a result, the risks this group assumed were not fully accounted for in the risk-management system. Soon thereafter, the group lost a large amount of money, forcing the undercapitalized bank to merge with another Swiss bank to create UBS. Clearly, organizations face trade-offs. Risk management might conceivably be structured to keep track of everything at all times—but it would probably be too costly to implement and, worse, would stifle innovation within the firm. In fast-moving markets, employees need to have flexibility in their trading.

Often, the largest profits are made in the newest securities. And employees will take risks more judiciously if their compensation is affected. Ironically, the risk manager who has most scrupulously modeled, measured, and captured knowable risk is perhaps most likely to trigger the fifth type of risk-management failure: poor communication to the board and the CEO, who are ultimately responsible for making decisions about risk. Even worse, information may reach top management too late or be distorted by intermediaries.

Communication failures have certainly played a role in the most recent crisis.

An Introduction to Value at Risk (VAR)

The reports did not, however, communicate an effective message for a number of reasons, in particular because the reports were overly complex, presented outdated data or were not made available to the right audience. Risk-management systems are extremely costly, and a CEO may be nonplussed to learn that all that money pays for imprecise estimates. Paradoxically, by developing a risk culture that accepts and understands the limitations involved, a firm can increase the value of risk management.

So far we have looked at risk management in terms of capturing a risk profile at a given point in time.

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But it is a dynamic process: Risk managers are responsible for making sure that the firm takes only the risks that it wants to take. Think about how you measure stock price risk.

Risk Japan

Suppose you model price returns using the normal distribution and you have no reason to believe that future returns will come from a different distribution. As long as the historical volatility and mean are a good proxy for the future behavior of stock returns, you will capture the relevant risk characteristics of the stock through your estimation of the statistical distribution of its returns. Other unknown risks may not matter simply because they have a trivially low probability.

There is some probability that any given building will be hit by an asteroid. That risk does not affect management decisions, and ignoring it has no implications for risk management.

Quick Overview

A few of these will always exist, of course, and the only way to account for them is to make available some capital over and above what your models predict you need. But here you have to enter the realm of intuition; by definition, a formal risk-management system will provide little guidance. This responsibility is more onerous for financial firms than for most others. Elsewhere risks change more slowly and usually involve a new exposure assumed through operations, such as sales or purchases denominated in foreign currencies.

But financial firms have many derivatives positions and positions with embedded derivatives; the associated risks can change sharply even if the firms take no new positions. These changes can be dizzying in periods of turmoil. Figuring out the right hedge when markets are moving rapidly is like trying to change an insurance policy on a house while it is burning.


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In an extreme example, in just one day a security might have an exposure to a stock price such that it gains substantially if the price rises but later have an exposure such that it loses substantially if the price rises. Suppose you hold what is called a barrier call option—an option that pays off only if the stock price stays below a certain level. Its value will start to fall as the stock price approaches the threshold.

For a product like this, hedges that are adjusted only daily could create large losses: A hedge that is optimal at the start of the day—say, a short position in the stock—might increase risk exposure at the end of the day if the stock price has risen. When the risk characteristics of securities can change quickly, it is challenging for risk monitors to capture changes and for risk managers to adjust hedges accordingly. The introduction of mark-to-market accounting actually makes it even harder for risk managers to estimate and adequately hedge risk.

In a way, marking to market has brought what is known as the observer effect into financial markets: For large organizations, observing the value of a complex security affects the value of that security. As losses become known through the process of marking to market, they start a chain reaction of adjustments at other institutions and affect the prices of possible trades as the market comes to better understand the capital positions of the institutions involved.

As the foregoing makes clear, conventional approaches to risk management present many pitfalls.

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Even in the best of times, if you are to manage risk effectively, you must make extremely good judgment calls involving data and metrics, have a clear sense of how all the moving parts work together, and communicate that well. In the worst of times, risk management can fall apart. Historical models can fail, liquidity can dry up, and correlations can become stronger without warning.

Solutions from outside the traditional framework will be required. Instead, augment the models you have with scenario analyses of how a financial crisis might unfold depending on how your firm and other large companies react to the crisis.

Introduction to Value at Risk for FRM I

In other words, take a leaf from the disaster-management handbook. Rather, you should think about what would happen to your organization if it was hit by one and how you would deal with the situation. Instead of focusing on the fact that the probabilities of catastrophic risks are extremely small, risk managers should build scenarios for such risks, and the organization should design strategies for surviving them. Risk management. March Issue Explore the Archive. Executive Summary Reprint: RG Financial risk management is hard to get right even in the best of times. In part through the failure of conventional risk-management approaches.

Failure in financial risk management takes essentially six forms, most of which are exemplified in the current crisis. For example, risk assessments are typically based on historical data, such as changes in house prices over time.

Market Risk - an overview | ScienceDirect Topics

But rapid financial innovation, including securitized subprime mortgages, has made such data unreliable. To prepare for the next crisis, take a leaf from the disaster-management handbook: Use scenario analyses to understand the various ways a crisis might unfold—and plan how your company would respond to each. Risk managers routinely make six fundamental mistakes: 1.

Risk managers simply overlook many types of risk and sometimes even create them. Interesting issues for academic scholars and students regarding the financial markets: - Foreign Exchange Transaction - Exchange Control Regulations in Thailand - Introduction to Government Debt Securities - Financial assistance to priority economic sectors - Market development.


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Financial Group. Financial Markets Money Market and Bond In a bid to maintain financial stability and ensure effective monetary policy implementation, the Bank of Thailand conducts Open Market Operations OMOs to keep short-term interest rate in the money market in line with the policy interest rate set by the Monetary Policy Committee.