Lecture04 - 4-1Market Risk and VAR (Value-at-Risk)...

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Unformatted text preview: 4-1Market Risk and VAR (Value-at-Risk) ModelsInstructor: Dr. QU BaozhiPhone: (852) 27887312Email:[email protected]: ACAD-P74074-2Market Risk◆This section discusses the nature of market risk and appropriate measures•Dollar exposure•VAR (Value-at-Risk) models»RiskMetrics»Historic or back simulation»Monte Carlo simulation•Links between market risk and capital requirements4-3Trading Risks◆Trading exposes banks to risks•1995 Barings Bank•1996 Sumitomo Corp. lost $2.6 billion in commodity futures trading•1997 market volatility in Eastern Europe and Asia •1998 continuation with Russian bonds•AllFirst/ Allied Irish $691 million loss4-4Implications◆Emphasizes importance of: •Measurement of exposure•Control mechanisms for direct market risk—and employee created risks•Hedging mechanisms4-5Market Risk◆Market risk is the uncertainty resulting from changes in market prices . •Affected by other risks such as interest rate risk and FX risk•It can be measured over periods as short as one day.•Usually measured in terms of dollar exposure amount or as a relative amount against some benchmark.4-6Market Risk Measurement◆Important in terms of:•Management information•Setting limits•Resource allocation (risk/return tradeoff)•Performance evaluation•Regulation»BIS and Fed regulate market risk via capital requirements leading to potential for overpricing of risks»Allowances for use of internal models to calculate capital requirements4-7Objective of VaR Models◆It can best be seen from the following quote by Dennis Weatherstone, former chairman of J.P. Morgan (JPM), now J.P. Morgan Chase:“At close of business each day tell me what the market risks are across all businesses and locations.”•In a nutshell, the chairman wants a single dollar number at 4:15PM that tells him the bank’s market risk exposure the next day – especially if that day turns out to be a “bad” day.4-8The Q&As Being Asked in VaR◆Q: “What loss level is such that we are X% confident it will not be exceeded in Nbusiness days?”◆A: “We are Xpercent certain that we will not lose more than VaRin the coming Ndays.”•With VaR= Value-at-Risk (days=N, prob.=99%)4-9...
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This note was uploaded on 02/22/2009 for the course ECONOMICS 4313 taught by Professor Tsui during the Spring '09 term at HKU.

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Lecture04 - 4-1Market Risk and VAR (Value-at-Risk)...

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