mplementing Quantitative Risk Management and VaR in a Chinese

Investment Bank Case Study Solution 

Part B
With the use of the different look back periods, such as 6 and 9 months at the
confidence level of 95 percent; the number of exceptions are calculated for 6
month period and 9 month period for both S&P and Shanghai stock exchange.
The exceptions for S&P for 6 and 9 months are 0.84 and 3.25, respectively, which
shows that the number of the actual observations exceeds above and over the
expected level of return calculated using the Variance-Covariance method. 
Additionally, the comparison between the exceptions for 6 month and 9 months
show that the exceptions have increased over the period of time.
On the other hand, the exceptions for Shanghai 6 and 9 months are 1.47 and
1.47, respectively, which shows that the number of the actual observations
exceeds above and over the expected level of return calculated using the
Variance-Covariance method. Additionally, the comparison between exceptions
for 6 month and 9 months show that the exceptions remained constant over the
period of time, thus changing the conclusion that the returns on S&P are lower
than the returns on Shanghai stock exchange.

Part C
The back testing truly supports the Value at Risk model due to the fact that one
could rely on the Value at Risk model as it passes a back test. Additionally, the
back testing tends to give the reality check on whether the forecast of Value at
Risk model are accurate and properly calibrated(Cakici, 2004). Not only this, it
also provides the Basel Committee with the critical technique of evaluation, to
test the adequacy of internal Value at Risk models.(Halilbegovic, 2016).

Part D
Jasper uses the back test results in order to confirm the reliability and accuracy
of the validation of the Value at Risk model, which indicates that Jasper needs to
make back-test a part of the daily Value at Risk calculations. The results drawn
from the back testing would provide him with valuable information and insights
regarding whether the potential risk or problem exist in core system of the
company or not, thus helping Jasper in taking necessary risk mitigation
measures & protecting the organizations from the potential future problem and
risks. Furthermore, Jasper could better utilize the Value at Risk model through
critically analyzing the adjusted returns for the given level of invested capital.
Based on the data provided, what would be the Conditional VaR

(CVaR) in this example? Explain your model and assumptions

The Conditional Value at Risk also referred to the expected shortfall which tends
to lead towards more conservative approach in terms of risk exposure. The
Conditional Value at Risk attempts to address the shortfalls of the Value at Risk
model, and is widely used to measure the financial risk level within the firm. The
formula used to calculate the values of CVaR, is as follows:
CVaR = (1/VaR) * Sum of returns of VaR
Whereas;
VaR = (1 – distribution level) * Count of total returns
On the basis of the provided data, on 5 percent distribution level; the company
would lose 1.98 value in the single day.Whereas Value at Risk 95 is positive in
S&P and negative in Shanghai to 2.18 and -1.98 percent, which means there is 5
percent chance that the company would lose 1.98 percent or more in the single
day. The assumptions of the Conditional Value at Risk model are as follows:

 The Conditional Value at Risk provides average lost value in the worst
case scenario.
 C-VaR values shows worse potential losses as compared to the
corresponding values of VaR because VaR in essence, ignoring the
worst possible returns or the fat tails of the distribution of historical
returns.
 The Conditional Value at Risk takes the weighted average of VaR.

Conclusion
Jasper Wang was concerned about how he would push more quantitative risk &
control framework in the face of the domain issues, dismissal of measures of
risk management used outside of China as well as the basic differences in the
culture about how the things are done within the domestic organization. He
made Value at Risk (VaR) the first step of rationalizing the function of trading,
because the staff and the traders didn’t stress over the significance of formal risk
management system, and Jianguo Lu also opposed the idea presented by Jasper
by stating that no formal risk management system could replace his years of
experience and expertise in the Chinese market.
The returns on S&P are greater than the returns on Shanghai stock exchange.
Jasper is required to witness how his plan would theoretically perform and could
gauge the efficiency of the trading strategy. The back testing truly supports the
Value at Risk model, due to the fact that one could rely on the Value at Risk
model as it passes a back test. Additionally, the back testing tends to give the
reality check on whether the forecast of Value at Risk model are accurate and
properly calibrated.Jasper used the back test results in order to confirm the
reliability and accuracy of the validation of the Value at Risk model, which
indicates that Jasper needs to make back-test a part of the daily Value at Risk
calculations..........
Implementing Quantitative Risk Management and VaR
in a Chinese Investment Bank Case Solution 
Introduction
Jasper Wang – the protagonist had an extensive experience in effective management or
risk exposure in the international financial-institutions. With speedy progress in the
Chinese economy;Jasper wanted to return back to China,to exploit the opportunity & he
was also convinced by the Chief Executive Officer of Guang Guo – one of the domestic
investment banks of China, to lead the risk management functions. He had intended to
introduce the international standards in the risk management as well as measurementin
the firm. He was concerned about how he would push more quantitative framework for
risk and control in the face of domain issues, dismissal of risk management measures
used outside of China as well as the basis differences in culture regarding how things
get done within the domestic organization.

Why does Jasper choose to make the VaR the first step towards
rationalizing the trading function? What is the appeal of the VaR model
generally?
Jasper Wang took the role of creating the formal risk management functions in the
Shanghai-based Guang Guo Investment bank. He was intrigued by the likelihood of
building the risk management functions of Guang Guo, with the ability to influence the
strategic direction of the company as a whole.

Over the period of time; Jasper came to realize that with the advent of new investment
opportunities, followed the economic boom in China, which made traders less interested
in continuing their commitments with the trading strategies of the bank, due to which he
had proposed the idea of implementing the simple trading limits as well as daily
reporting of profit and loss, but his ideas was not given enough importance by Jianguo
Lu, who was in charge of asset allocation as well as the trading strategy. Additionally, he
was struck by visible disconnect between the enthusiasm of CEO and the lack of
concern of operating and trading team of the company in effective management of risk.
Due to this reason, he contemplated to make the statistical Value at Risk (VaR)
framework one of the key centerpiece of his efforts.

He made Value at Risk (VaR) the first step of rationalizing the function of trading,
because of the reason that the staff and the traders didn’t stress over the significance of
formal risk management system. Also, Jianguo Lu also opposed the idea presented by
Jasper, by stating that no formal risk management system could replace his years of
experience and expertise in the Chinese market, and he also stipulated that no statistical
model could be successful in capturing the Shanghai equity markets, which were
dominated by the speculative retailinvestors who were highly prone to uncertain
fluctuations. Also, he analyzed that no one at Guang Guo stressed over the significance
of analyzing the range of the possible outcomes of the activities and make comparison
of profit and loss from specific type of trades to the capital that was invested at risk and
no one was evaluating the risk adjusted returns on the activities, which were helpful in
evaluating the performance of the fund or asset class and tended to help make better
investment decisions.

Furthermore, his purpose of introducing the Value at Risk (VaR) model is a mean of
quantifying the risks of the various trading desk, which could be useful in calculating the
maximum expected loss on the investment over the period of time. Moreover, he
intended to use the model to determine the level of exposure as well as the potential
losses of the trading portfolio, in order take required measures to control the risk in
trading. Additionally, the model would allow the company to ensure that the firm was
earning adequate risks-adjusted returns on the activities. The benefits of using the Value
at Risk also included that it measures the market risks, which tend to combine the
sensitivity of the portfolio to the changes in market and the probability of the given
market change.(Alexandra, 2015).

Based on the excel data provided, run backtests of the VaR predictions
against actual daily gains or losses for both the S&P 500 index and the
Shanghai index using the following parameters:
The Value at Risk is calculated by using the Variance-covariance method,which
calculates the standard deviation of the returns for each S&P and
Shanghai.TheVariance-covariance provides a clear picture of the most likely return on
the asset, and only requires expected returns and its standard deviation. The standard
deviation of the historical returns provides strong foundation of predicting the volatility
in returns, in the forthcoming years. By assuming that the daily returns on the assets
follows the normal distribution with mean, which is equal to zero; the Value at Risk
model at the confidence level is calculated using the formula provided below:

VaRc = z * σ

Part A
The simple back test stacks up the actual return on the asset against the forecasted
Value at Risk return, in order to calculate the number of exceptions. The number of
exceptions occur if the value of loss is greater than the forecaster Value at Risk value.

In the developed model, the number of exceptions are calculated for 3 months’ time
period for both S&P and Shanghai stock exchange. The exceptions for S&P one month,
two month and three months,are: 3.31, 1.72 and 0.85, respectively, which shows that the
number of the actual observations exceed above and over the expected level of return
calculated using Variance-Covariance method.

On the other hand, the exceptions for Shanghai one month, two month and three months
are:1.18, 1.44 and 1.48, respectively, which shows that the number of the actual
observations exceeds above and over the expected level of return calculated using the
Variance-Covariance method.

As per the concept, the good Value at Risk model tends to generate high number of
exceptions; the exceptions calculated for S&P is greater as compared to exceptions
calculated for Shanghai stock exchange,except for third month, which implies that the
returns on S&P are greater than the returns on Shanghai stock exchange. Thus, Jasper is
required to witness how his plan would theoretically perform and could gauge the
efficiency of the trading strategy……..