# John Hull Chapter 14.pdf - Model-Building Approach Chapter...

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Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018Chapter 14Model-BuildingApproach1
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018The Model-Building ApproachThe main alternative to historical simulation forcalculating VaR or ES is to make assumptionsabout the probability distributions of the returnson the market variablesThis is known as the model building approach(or sometimes the variance-covariance approach)2
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018Microsoft Example(page 318-319)We have a position worth \$10 million inMicrosoft sharesThe volatility of Microsoft is 2% per day(about 32% per year)We useN=10 andX=993
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018Microsoft Example continuedThe standard deviation of the change inthe portfolio in 1 day is \$200,000The standard deviation of the change in10 days is4
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018Microsoft ExamplecontinuedWe assume that the expected change inthe value of the portfolio is zero (This isOK for short time periods)We assume that the change in the valueof the portfolio is normally distributedSinceN(–2.326)=0.01, the VaR is5
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018AT&T ExampleConsider a position of \$5 million in AT&TThe daily volatility of AT&T is 1% (approx16% per year)The SD per 10 days isThe VaR is6
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018Two-Asset Portfolio(page 319-320)Now consider a portfolio consisting of bothMicrosoft and AT&TSuppose that the correlation between thereturns is 0.37
Risk Management and Financial Institutions 5e, Chapter 14, Copyright © John C. Hull 2018S.D. of PortfolioA standard result in statistics states thatIn this caseX= 200,000 andY= 50,000and= 0.3. The standard deviation of thechange in the portfolio value in one day istherefore 220,2008

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Term
Winter
Professor
Yao Jiangang
Tags
John C Hull