Market Risk

• What is Market Risk?


  the possibility that the value of an investment may decrease due to changes in the market
• Forms of Market Risk 


  (depends on underlying asset)

  • Equity risk

  • Interest rate risk

  • Currency risk

  • Commodity price risk
• The determinants of market risk


  • General market risk

  • Specific market risk

  • Basis market risk
• Market Risk Management 


  Diversification, Strategies, Monitoring
• VaR Mission 


  1). Ensure that management is informed about the risk profile.

  2). Protect the financial institution against unacceptable large losses.
• Why VaR? (how it can be used to manage risk)

  1. VaR is a quantitative measure
  2. VaR considers a range of market scenarios
  3. VaR is flexible
  4. VaR is widely used
• 
  

  VaR main principles 


  • Time horizon

  • Confidence level

  • Historical data

  • Normal distribution

  • Portfolio aggregation

  • Stress testing
• Different Methods to Measure VaR


  Historical Method (non-parametric)

  variance-covariance method (parametric)

  Monte Carlo Simulation Method
• Advantages of VaR

  1)A widely used methodology for measuring market risk.

  2) It provides a useful estimate of the potential loss of an investment or portfolio over a specified time period.

  3) It can be used in conjunction with other risk management tools and techniques to provide a more comprehensive assessment of risk.
• Disadvantages of VaR

  1)Limitations of the normal distribution assumption.

  2) VaR estimates are only as good as the input data.

  3) VaR does not capture tail risk.

  4) VaR estimates may be misinterpreted and manipulated
• What is VaR


  is the chance of losing a potential amount over the holding period with a certain confidence level.