Shortcomings of risk metrics
ANSWER
-May not scale over time
-Historical data may be meaningless
-Not designed to account for catastrophes
-VaR says nothing about losses in excess of VaR
-May not handle sudden illiquidity
Importance of communication for risk managers
ANSWER
Need to assess risk and tell management so they can determine which risks to take on
Ways firms can fail to account for risks
ANSWER
-Firm may ignore known risk
-Somebody in firm may know about risk, but it's not captured by models
-Realization of a truly unknown risk
Ways risk can be mismeasured
ANSWER
-Wrong distribution
1
,-Historical sample may not apply
Roles of risk management
ANSWER
-Asses firm risks
-Communicate risks
-Manage and monitor risks
Practical considerations related to ERM implementation
ANSWER
-Designate ERM champion - usually CRO
-Make ERM part of firm culture
-Determining all possible risks
-Quantifying operational and strategic risks
-Integrating risks (dependencies)
-Lack of risk transfer mechanisms
-Monitoring
Risk types addressed by ERM
ANSWER
-Hazard
-Financial
-Operational
-Strategic
2
,Models used in ERM framework
ANSWER
Modeling approach is typically between statistical analytic models and structural simulation
models
Traits of ERM
ANSWER
-Enterprise Risk Management
-ERM is a discipline - culture of enterprise
-ERM applies to all industries
-ERM is not just defensive, adds value
-ERM encompasses all risks
-ERM addresses all stakeholders
Risk-adjusted performance measure (RAP)
ANSWER
-Relationship drawn from CML
-RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate
-annualized
VaR-based analysis (formula)
ANSWER
-Risk replaced with VaR
3
, (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Information ratio
ANSWER
IR = (E(Rp) - E(Rb))/(std dev(Rp-Rb))
-Evaluate manager of a benchmark fund
Sortino ratio
ANSWER
Sortino ratio = (E(Rp) -R_min)/sqrt(MSD_min)
MSD_min=summation(R_pt-R_min)^2/N
where R_pt is return of the portfolio at time t
-MAR - minimum acceptable return also denoted as R_min is the diff between Sortino and
Sharpe
Tracking error
ANSWER
-Std dev between portfolio return and benchmark return
TE = std dev * (Rp-Rb)
-Benchmark funds
Treynor measure
ANSWER
-Excess return divided by portfolio beta
4
ANSWER
-May not scale over time
-Historical data may be meaningless
-Not designed to account for catastrophes
-VaR says nothing about losses in excess of VaR
-May not handle sudden illiquidity
Importance of communication for risk managers
ANSWER
Need to assess risk and tell management so they can determine which risks to take on
Ways firms can fail to account for risks
ANSWER
-Firm may ignore known risk
-Somebody in firm may know about risk, but it's not captured by models
-Realization of a truly unknown risk
Ways risk can be mismeasured
ANSWER
-Wrong distribution
1
,-Historical sample may not apply
Roles of risk management
ANSWER
-Asses firm risks
-Communicate risks
-Manage and monitor risks
Practical considerations related to ERM implementation
ANSWER
-Designate ERM champion - usually CRO
-Make ERM part of firm culture
-Determining all possible risks
-Quantifying operational and strategic risks
-Integrating risks (dependencies)
-Lack of risk transfer mechanisms
-Monitoring
Risk types addressed by ERM
ANSWER
-Hazard
-Financial
-Operational
-Strategic
2
,Models used in ERM framework
ANSWER
Modeling approach is typically between statistical analytic models and structural simulation
models
Traits of ERM
ANSWER
-Enterprise Risk Management
-ERM is a discipline - culture of enterprise
-ERM applies to all industries
-ERM is not just defensive, adds value
-ERM encompasses all risks
-ERM addresses all stakeholders
Risk-adjusted performance measure (RAP)
ANSWER
-Relationship drawn from CML
-RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate
-annualized
VaR-based analysis (formula)
ANSWER
-Risk replaced with VaR
3
, (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Information ratio
ANSWER
IR = (E(Rp) - E(Rb))/(std dev(Rp-Rb))
-Evaluate manager of a benchmark fund
Sortino ratio
ANSWER
Sortino ratio = (E(Rp) -R_min)/sqrt(MSD_min)
MSD_min=summation(R_pt-R_min)^2/N
where R_pt is return of the portfolio at time t
-MAR - minimum acceptable return also denoted as R_min is the diff between Sortino and
Sharpe
Tracking error
ANSWER
-Std dev between portfolio return and benchmark return
TE = std dev * (Rp-Rb)
-Benchmark funds
Treynor measure
ANSWER
-Excess return divided by portfolio beta
4
