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INTRODUCTION TO RISK SYSTEMS
Dr Philip Symes
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I. INTRODUCTION
II. TYPES OF RISK
III. VAR AND OTHER RISK METRICS
IV. CALCULATING VAR
V. REPORTING RISK
VI. SUMMARY
Agenda
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All inves!ens "ave an in"e#en #is$.

F%# a &%nd' (%# e)a!*le' "e#e a#e "e (%ll%+ing #is$s,

T"e #is$ "a "e &%nd +ill de(a-l.

T"e #is$ "a "e &%nd +ill deval-e' e.g. d-e % IR

/"anges.

O"e# #is$s' s-/" as "e /%!*-e# s0se! (ailing

+"en 0%- #e/eive *a0!en (#%! "e &%nd a !a-#i0.

T"ese #is$s /an &e 1-ani(ied -sing seve#al !e"%ds.

T"e#e a#e als% ine#nai%nal #eg-lai%ns 2e.g. 3asel45

"a li!i "e #is$ &an$s /an a$e.
In#%d-/i%n
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In "e *#evi%-s slide +e /%nside#ed s%!e #is$ (a/%#s

ass%/iaed +i" &%nds.

Les l%%$ /l%se# a "e $e0 #is$ /%!*%nens %( a

dive#si(ied /%!*an0,
T0*es %( Ris$
Key Risk Components
Ma#$e Ris$
C#edi Ris$
O*e#ai%nal
Ris$
Asset
Management
Ins-#an/e
Ris$
Risk Adjusted
Performance
Measurement
Capital
Allocation
Risk
Management
Shareholder
Value Added
S#aegi/
3-siness
Ris$
Insurance
Retail
Banking
Capital
Markets
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De(inii%n %( $e0 #is$ /%!*%nens

T#ading and Ma#$e #is$

E)*%s-#e %( a insi-i%n6s (inan/ial /%ndii%n % adve#se

!%ve!ens %( !a#$e *a#a!ee#s 2#aes75.

T"e !%s devel%*ed a#ea %( #is$ !anage!en' &-

insi-i%ns a#e sill invesing in "is a#ea.

C#edi #is$

Ris$ "a l%sses a#e in/-#s i( a /-s%!e# d%es n% (-l(il is

(inan/ial %&ligai%ns.

T"is is "e !a8%# (%/-s %( #eg-la%#0 aeni%n and is

"eavil0 (ea-#ed in 3asel4 *#%*%sals.

9i" "e #end % /%ns%lidai%n and gl%&alisai%n' (i#!:+ide

/#edi #is$ !anage!en &e/%!es &%" "a#de# and !%#e
i!*%#an.
T0*es %( Ris$
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O"e# $e0 #is$ /%!*%nens

O*e#ai%nal #is$

E)*%s-#e /#eaed &0 de(i/ien/ies %( IT' *#%/esses

and /%n#%ls "a !a0 #es-l in -ne)*e/ed l%sses.

T"is is an%"e# a#ea %( in/#eased #eg-la%#0 aeni%n.

Ins-#an/e ; 3-siness S#aeg0 Ris$s

C%nve#gen/e %( "e 3an$ing and Ins-#an/e !a#$es

3e0%nd "e s/%*e %( "is *#esenai%n

T0*es %( Ris$
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An0 !a#$e #is$ *#%8e/ "as % &alan/e "e g%als %( "#ee
g#%-*s...

Seni%# !anage!en

<A**les % a**les= /%!*a#is%n %( #is$s a/#%ss !-li*le

&-sinesses

P#%vide &asis (%# (--#e e/%n%!i/ /a*ial all%/ai%n

de/isi%ns

Ris$ /%n#%lling

Sais(0 #eg-la%#0 #e1-i#e!ens and !ini!ise #eg-la%#0

/a*ial #e1-i#e!ens

Clea#' -na!&ig-%-s !eas-#e %( !a#$e #is$ as "e &asis

(%# #e*%#ing and li!iing #is$ a$ing

Ris$ !anage#s>T#ade#s

T%%ls % -nde#sand "e #is$ in #aded *%sii%n

Need % *e#(%#! ad "%/ anal0ses

Tes n%vel #is$ !e#i/s

VAR and %"e# Ris$ Me#i/s
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VAR and %"e# Ris$ Me#i/s

Val-e A Ris$ is "e ind-s#0 sanda#d !e"%d%l%g0,

I saes "a' a a /e#ain /%n(iden/e li!i 2e.g. ??@5

n% !%#e "a Ax +ill &e l%s in a T da0 *e#i%d.

T"e /-##en val-e %( *%#(%li% is -sed (%# *#edi/ing

l%sses.

VAR is "e !e"%d s*e/i(ied in 3asel 4.

Ma#ginal VAR 2MVAR5 is an e)ensi%n % "e VAR

*#in/i*le,

I s"%+s "e a!%-n %( #is$ a *a#i/-la# *%sii%n is

adding % *%#(%li%.

I -ses "e *a#a!e#i/ a**#%a/" % se*a#ae %- "e

#is$s and (ind /%##elai%ns.
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VAR and %"e# Ris$ Me#i/s

In/#e!enal VAR 2IVAR5is si!ila# % MVAR,

IVAR -ses MVAR % ad8-s *%#(%li% #is$.

I s"%+s "e sensiivi0 %( VAR % *%#(%li% /"anges.

H%+eve#' "e#e a#e seve#al d#a+&a/$s +i" VAR,

T"e#e is n% esi!ae %( "e siBe %( l%sses %n/e "e

VAR li!i is e)/eeded.

VAR is n% a /%"e#en !eas-#e %( #is$.

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. . . Clea#l0' "%-g"' #ade#s and &-siness -ni #is$
!anage#s need signi(i/an in(%#!ai%n in addii%n %
VAR,

S#ess ess

S/ena#i% anal0sis

G#ee$s and sensiivi0 !eas-#es

S#ess <g#ids= (%# %*i%ns

<H% s*%= and /%n#i&-%#0 VAR anal0sis

3es "edge anal0sis 2(%# linea# *#%d-/s5

Li1-idi0 #is$ indi/a%#s

P>L "is%#ies
VAR and %"e# Ris$ Me#i/s
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VAR and %"e# Ris$ Me#i/s

E)*e/ed s"%#(all 2ES5 *#%vides !%#e in(%#!ai%n "an

VAR %n ail %( "e P;L dis#i&-i%n,

I gives an ave#age !eas-#e %( "%+ "eav0 "e ail is.

I is a /%nve) (-n/i%n %( *%#(%li% +eig"s

-se(-l (%# #is$ %*i!isai%n.

T"e ES is al+a0s "ig"e# "an "e VAR.

ES is a /%"e#en #is$ !eas-#e.

C%!&ined +i" VAR' ES gives a !eas-#e %( "e /%s %(

ins-#ing *%#(%li% l%sses

T"ese +% !e"%ds a#e /%!*le!ena#0.

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T"e#e a#e "#ee gene#i/ a**#%a/"es % !eas-#ing VAR

Pa#a!e#i/ VAR is "e si!*les a**#%a/" and a//-#ael0

!eas-#es VAR (%# ins#-!ens +i" linea#' n%#!al
#e-#ns

M%ne Ca#l% Si!-lai%n all%+s "e #ela)ai%n %( "e

ass-!*i%ns %( linea#i0

His%#i/al Si!-lai%n all%+s "e #ela)ai%n %( "e

ass-!*i%ns %( &%" linea#i0 and n%#!ali0
C%!*a#is%n %( VAR Te/"ni1-es
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F r e q
D i s t r i b u t i o n o f
P V
0
V a R : = 9 5 t h % i l e
P V
P O S
1
x
d P
d R F
1
P O S
n
x
d P
d R F
n
=
=
P

P
R F
n

R F
1
= W
.
.
.
.
.
.

2
G e n e r a t e s c e n a r i o s f o r e a c h r i s k f a c t o r b y a p p l y i n g
v e c t o r o f p e r c e n t a g e c h a n g e s t o c u r r e n t m a r k e t
v a l u e ( R F
i
o
) :
2
C a l c u l a t e t h e i m p l i e d c h a n g e i n p o r t f o l i o N P V f o r e a c h
s c e n a r i o a n d s o r t r e s u l t s :
.
.
.
P V
1 5
P V
2 1 5
P V
3 5
P V
9 5 6
S c e n a r i o 1
S c e n a r i o 2
S c e n a r i o 3
S c e n a r i o N
.
.
.
.
.
.
P V
N
P V
1
P V
2
P V
3
S o r t i n
a s c e n d i n g
o r d e r
2
C a l c u l a t e v e c t o r o f p o r t f o l i o r i s k f a c t o r s e n s i t i v i t i e s :
1
U s i n g h i s t o r i c a l r e t u r n d a t a , c a l c u l a t e p a r a m e t e r s o f v a r i a n c e /
c o v a r i a n c e m a t r i x , C
M
C a l c u l a t e V a R : 3
1
B a s e d o n r i s k f a c t o r d y n a m i c s , g e n e r a t e s c e n a r i o s
f o r e a c h r i s k f a c t o r :
F r e q
1
2
3
N
C u r r e n t
V a l u e
D a y s
5
1 0
C u r r e n t
V a l u e
F r e q
1
2
3
N
D a y s
5 1 0
C a l c u l a t e V a R : ( i d e n t i f y 9 5 t h % i l e N P V )
3
1
B a s e d o n h i s t o r i c a l p r i c e d a t a o v e r t h e l a s t 2 5 0
t r a d i n g d a y s , c a l c u l a t e t h e p e r c e n t a g e c h a n g e i n
e a c h r i s k f a c t o r :
R F
i
1
= R F
i
0
x ( 1 + % R F
i
- 1
)

R F
i
2
= R F
i
0
x ( 1 + % R F
i
- 2
)

.
.
.
R F
i
2 4 9
= R F
i
0
x ( 1 + % R F
i
- 2 4 9
)
C a l c u l a t e V a R : ( s e e s t e p s 2 & 3 f o r M o n t e C a r l o
s i m u l a t i o n )
3
% R F
i
- 2 4 9
= ( R F
i
- 2 4 9
- R F
i
- 2 5 0
) / R F
i
- 2 5 0
% R F
i
- 2 4 8
= ( R F
i
- 2 4 8
- R F
i
- 2 4 9
) / R F
2
- 2 4 9
% R F
i
- 1
= ( R F
i
- 1
- R F
i
- 2
) / R F
i
- 2
.
.
.
P A R A M E T R I C V A R M O N T E C A R L O S I M U L A T I O N H I S T O R I C A L S I M U L A T I O N

1 1

n 1

n n

1 n

1 1

n 1

n n

1 n

i j
V a R : = 9 5 t h % i l e V a R : = 9 5 t h % i l e

T"e "#ee !%dels "ave signi(i/anl0 di((e#en !e"%ds

(%# a##iving a a Val-e:a:Ris$ #es-l . . .
C%!*a#is%n %( VAR Te/"ni1-es
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. . . And /%##es*%ndingl0 di((e#en advanages and
disadvanages
C%!*a#is%n %( VAR Te/"ni1-es
ADVANTAGES DISADVANTAGES
Parametric
Eas0 % in/%#*%#ae !an0 #is$
(a/%#s
Daa !a#i/es +idel0
availa&le
P#%vides s#%ng !anage!en
in-ii%n a&%- s%-#/es %( #is$
Ass-!es n%#!ali0 %(
dis#i&-i%ns
Fails % /a*-#e n%n:linea#i0
%( %*i%ns
Monte Carlo
Simulation
P#%vides a//-#ae #is$
!eas-#es (%# %*i%ns
C%!*-ai%nall0 inensive ;
#e1-i#es addii%nal
a**#%)i!ai%ns (%# !-li*le
#is$ (a/%#s
P#%vides lile !anage!en
in-ii%n
istorical
Simulation
Si!*le' #e1-i#es *#i/ing
!%del and "is%#i/al daa %nl0
Ca*-#es "is%#i/al <(#ea$=
evens
Re1-i#es la#ge a!%-ns %(
"is%#i/al daa
S#%ngl0 de*enden %n "e
*a#i/-la# daa sa!*le
P#%vides lile !anage!en
in-ii%n
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His%#i/al si!-lai%n is &e/%!ing "e ind-s#0 sanda#d

(%# &an$:+ide #is$ !eas-#e!en

T"ese n-!&e#s a#e &ased %n an O9C:s-#ve0 %n #is$

!anage!en (%# #aded *#%d-/s
C%!*a#is%n %( VAR Te/"ni1-es
C
DC
4C
EC
FC
GC
HC
IC
N%ne Pa#a!e#i/ M%ne:Ca#l% His%#i/al
D??H
D???
Pa#i/i*ans in D??H, G inves!en &an$s' F ine#nai%nal &an$s' F /%!!e#/ial &an$s
Pa#i/i*ans in D???, H inves!en &an$s' E ine#nai%nal &an$s and 4 /%!!e#/ial &an$s 2s% (a#5
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T"e *#in/i*al #is$ !e#i/ is a "is%#i/al si!-lai%n &ased VAR . . .

VAR !ees "e needs %( seni%# !anage!en . . .

Reg-la%#0 #e1-i#e!ens

A/#%ss &-siness /%!*a#is%ns

3asis (%# e/%n%!i/ /a*ial

. . . And /an &e -sed &0 Ris$ C%n#%lling>Manage!en %

Li!i #is$ d%+n % des$ %n eve# individ-al #ade# levels

Re*%# #is$ #a/$ing

His%#i/al si!-lai%n is /-##enl0 "e %*i!al VAR

!e"%d%l%g0 /"%i/e

I /a*-#es "e e((e/s %( &%" n%n:n%#!ali0 and n%n:

linea#i0

I is &e/%!ing de (a/% ind-s#0 sanda#d

I a**ea#s % en8%0 "e a/i end%#se!en %( #eg-la%#s

I is /%!*-ai%nall0 #a/a&le
C%!*a#is%n %( VAR Te/"ni1-es
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T"e $e0 de/isi%ns s-##%-nding "e "is%#i/al si!-lai%n
a**#%a/" a#e

9"a i!e *e#i%d s"%-ld &e -sed, 4GC da0s -sed % &e
sanda#d &- "e #end is % -se l%nge# daa ses.

9"a daa s"%-ld &e -sed,

C#edi s*#eads a#e /-##enl0 !issing

H%+ s"%-ld !issing daa &e deal +i"

H%+ s"%-ld /"anges e.g. in indi/es &e "andled

H%+ s"%-ld !%del de#ived daa e.g. i!*lied

v%lailiies &e "andled

H%+ %(en s"%-ld "e daa &e #e(#es"ed

Dail0, M%#e a//-#ae &- "a#de# % i!*le!en

Pe#i%di/all0, slig"l0 less a//-#ae &- easie# %

i!*le!en

3a/$esing !e"%d%l%g0 2#e1-i#ed &0 3asel45

C%!*a#is%n %( VAR Te/"ni1-es
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Ris$ Re*%#ing A**#%a/"

A "e si!*les level' #e*%#ing is 8-s a P;L "is%g#a!

S"%+s VAR and e)*e/ed s"%#(all

MC s"%+s l%+es
(ig-#es
J Ris$Me#i/s
His%#i/al si!-lai%n
s"%+s !%s
/%nse#vaive (ig-#es
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A +ide #ange %( li!is is se : di((e#eniaed &0 *#%d-/ line,

VAR li!is

-s-all0 s%( 2n% in#a:da0 /"e/$ing /a*a&iliies5

S/ena#i% ess

+idel0 seen as "e &es #is$ !anage!en %%l

N%!inal li!is

% ass-#e dive#si(i/ai%n

G#ee$s li!is

!ainl0 se %n des$ > #ade# level

Se*:l%ss ; P;L li!is

% !anage !a)i!al l%sses

Ris$ Re*%#ing A**#%a/"
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A *#%*e# -nde#sanding %( #is$ ena&les &an$s %

%*i!ise "ei# /a*ial !anage!en.

Ris$ /an gene#all0 &e s*li in% !a#$e' /#edi and

%*e#ai%nal #is$s.

VAR is "e !%s *%*-la# #is$ !eas-#e' &- s"%-ld n% &e

-sed %n is %+n.

T"e !%s *%*-la# +a0 %( /al/-laing VAR is &0 "is%#i/al

si!-lai%n.

T"is !e"%d is s*e/i(ied as an a**#%a/" in "e 3asel 4

*#%%/%l.
S-!!a#0