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Lecture - 6 Chap010 PDF
Lecture - 6 Chap010 PDF
Chapter 10
Market Risk
Overview
• This chapter discusses the nature of market risk
and appropriate measures
– Dollar exposure
– Risk Metrics
– Historic or back simulation
– Monte Carlo simulation
– Links between market risk and capital requirements
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Market Risk
• Trading Portfolio….????
• Market Conditions…???
Market Conditions
• Market conditions are the extreme changes in market
such as the prices of an Asset, Interest rates, Market
volatility, and Market liquidity.
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Trading Portfolio
• The Trading Portfolio contains assets, liabilities, and
derivative contracts that can be quickly bought or sold
on organized financial markets.
• Such as
– Long and Short positions in Bonds,
– Commodities
– Foreign exchange,
– Equity securities,
– interest rate swaps, and options etc
Trading Portfolio
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Trading Risks
• In recent years, market risk of FIs has raised
considerable concern among regulators
• Trading exposes banks to risks
o 1995 Barings Bank
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• This is very typical for the major money canter banks, large
overseas banks (e.g., Deutsche Bank, Barclays ), and major
insurance companies and Investment Banks(Morgan Stanley,
Goldman Sashs ).
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RiskMetrics Model
• Here we will concentrate on measuring the Market
Risk Exposure of a FI on a daily basis.
RiskMetrics Model
• More specifically, the market risk is measured in
terms of the FI’s Daily Earnings At Risk (DEAR)
• Components of Dear:
1. Dollar value of position
2. Price Sensitivity
3. Potential Adverse move in yield
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RiskMetrics Model
• Since
RiskMetrics Model
• We concentrate on how the RiskMetrics model
calculates daily earnings at risk in three trading
areas
1. Fixed income
2. Foreign exchange (FX)
3. Equities
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1,631,483
– ళ = $1,000,000
(1.07243)
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Confidence Intervals
• Suppose we define “bad” yield changes such that there is only 5%
chance of the yield change being exceeded in either direction.
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Confidence Intervals
• Suppose the standard deviation of the bond was 10 Bb
(or 0.001).
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• In other words, during the last year, the euro declined in value
against the dollar by 93.2 bp just 5% of the time
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• If over the last year, the σM of the daily returns on the stock
market index was 200 bp.
• Then 1.65 σM = 330 bp (i.e., the adverse change daily return on
the stock market index exceeded 330 bp only 5% of the time).
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• Three-asset case:
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