what are the milestones of risk management in the last two decades?
e milestones are the 1988 regulation on capital adequacy by the Basel Committee, the release of RiskMetricsTM Technical Document by JP Morgan in 1994, and the release of Basel-II by the Basel Committee in 2000.
Which disciplines has risk management been the meeting point of?
The fascinating progress and development of risk management has been the meeting point of several disciplines, among which are statistics, computer science, and econometrics.
what is the definiton of risk?
There is no uniform definition, but generally, it is defined as the probability of facing loss or unintended consequences. Here is the definition Cecchetti and Schoenholtz propose: Risk is a measure of uncertainty about the future payoff an investment, assessed over a particular time horizon and relative to a benchmark. To rephrase the definition, we can say that, from a financial perspective, risk is the degree of uncertainty about the return of future net cash flows generated from a particular investment.
What is market risk?
Market risk can be defined as the risk related to a financial institution’s financial condition resulting from unexpected market movements in the price level of certain risk factors. These risk factors can be categorized into four main classes: equity prices, commodity prices, foreign exchange rates, and interest rates.
Why traditional risk management and measurement tools are no longer sufficient to address the risks?
Because the factors behind the new dynamic market structure are complex. For example, increased volatility in foreign exchange and interest rates and the emergence of new financial products within the last two decades have significantly changed the nature of financial markets. Also, significant advances in information technology and telecommunications, along with the growth in trading volume and sophistication, have led to the emergence of a new era in finance. In this environment, traditional risk management and measurement tools are no longer sufficient to address the risks inherent in complex portfolios composed of multiple instruments displaying both linear and non-linear characteristics.
What is the purpose of Basel I and Fisher Report?
The first three series of banking regulations, namely, Basel I and Fisher Report were all set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regard to credit risk and market risk. The purpose of the accords and following amendments is to ensure that financial institutions have enough capital on account to meet their obligations and absorb unexpected losses.
What are the major risk categories that the Basel Committee has defined?
These are a market risk, credit risk, operational risk, and liquidity risk.
With the Basel documentations, banks' activities have been separated into which groups?
With the Basel documentations, the risks have been categorized into two main groups; banks’ activities have been separated into the trading book and the banking book; the former refers to market risk components, and the latter, to credit risk.
Which risk category comes with Basel-II?
With the evolution of the Basel-II, a new set of risks, called operational risk, was added to the regulation.
What is the definition of market risk according to the Basel Committee?
According to the Basel Committee, market risk is defined as the risk of losses arising from movements in market prices.
What are the two main methods Basel uses to assess market risk?
Value-at-risk (VAR) and expected shortfall (ES)
What is the main difference between Var and ES?
To compare the definition of VaR and ES, we can say that the former asks the question ‘how bad can things get (with a pre-specified probability level on a single day)?’, while the latter answers the question ‘if things get worse, what is our expected loss?’.
What are the two methodologies the Basel Committee permits banks to choose between for calculating their risk-based capital requirements for credit risk?
The first is standardized approach, and the second is the internal ratings-based (IRB) approach.
What is the operational risk according to the Basel Committee?
Operational risk is simply any event that disrupts the normal ow of business processes and which generates financial loss or damage to the image of the bank (although the latter outcome has been explicitly excluded from the definition of the Basel Committee, still remains as a major concern).
What is the expected return definition in finance?
In finance, it should be defined in statisticians’ terms: Mean value of returns. The expected return from this perspective is the weighted sum of expected returns with associated probabilities.
In financial realm, how can we calculate risk?
By calculating the volatility of expected asset returns. to do this, we simply calculate the standard deviation of the annual return.
How investors reduce their risks while searching for higher returns?
One of the widely used methods is to construct an efficient portfolio. However, we should always bear in mind that certain risks cannot be eliminated by diversifying.
Which question does VaR answer?
VaR answers the question: how much can I lose with x % probability over a given time horizon.
How many VaR calculation methods are there?
Methods used for the calculation of VaR differ in their broad methodology and the assumptions they make. But most broadly used ones are, variance-covariance, historical simulation, Monte Carlo simulation, and extreme value theory.
What is the definition of financial derivatives according to The Group of Thirty's?
The Group of irty’s (1993) excellent definition of financial derivatives is: “In the most general terms, a derivatives transaction is a bilateral contract or payments exchange agreement whose value derives, as its name implies, from the value of an underlying asset or underlying reference rate or index. Today, derivatives transactions cover a broad range of “underlying”—interest rates, exchange rates, commodities, equities, and other indices”.