31. Risk Management at a Glance Appendix: General Comments on Risk Management Portfolio & Politics Markets Systems Risk Manag.
32.
33. The Risk Management Process Shaping It (Reporting) Positions Data Market Data Historical Risk Data Models Assumptions Selecting Risk Metrics Selecting Risk Factors Calculating Exposures Running Reports Analyzing the reports Testing the assumptions Building forecasts Turning into actions Basic Ingredients (Inputs) Baking It (Analysis) The Proof is in the Pudding Appendix: General Comments on Risk Management
34. Risk Management: Systems Appendix: General Comments on Risk Management Administrator Counter-parties Pricing (BBRG, Markit, LoanX) Historical Time Series Scenario Engine Report Generation Distribution Follow-Up Analysis
35.
36.
37.
38.
39.
Editor's Notes
Notes: The first objective of risk management is to make sure that the investment profile of the portfolio is in line with what portfolio manager (and investors) expect. That includes measuring portfolio’s performance through appropriate benchmarks, and communicating the results back to the portfolio manager (and investors). In order to improve the risk profile of the portfolio, risk manager might suggest to re-allocate asset between sectors or asset classes, to make the portfolio more diversified or more concentrated. 2. The second objective of risk management is to hedge out unwanted risks (market risk or issuer-specific risk). It is important to remember that: It is impossible and undesirable to offset all risks. No risk – no return. Hedging in reality swaps one kind of risk for another. By offsetting market risk we introduce basis risk between the position and the hedge. In reality all investments have non-linear profile. Every investment is either like “selling lottery tickets” (small gains most of the time, large losses from time to time) or “buying lottery tickets” (large but rate gains and small but often losses). Because of non-linearity, there are no perfect hedges. The alpha is in the ability to price the risks on the position – for example, finding under-priced bonds is like “selling expensive lottery tickets” or “buying cheap lottery tickets”. In order not to hedge the alpha away, the risk manager has to using the right instruments for hedging, for example “buy cheap lottery tickets” by investing in under-priced options or CDS. 3. The third objective is to preserve the business from tail events. The most danger here rests in the change of market regime which can simultaneously affect many positions in the portfolio (delay catalysts, apply technical pressure etc.). Therefore, the portfolio manager has to think forward about the connections between the positions in the portfolio and the market, and how those positions can be negatively affected and become more correlated than initially expected. 4. One of the secondary objectives of risk management therefore is proper reporting of portfolio’s composition, performance metrics and risk parameters.
This chart talks more about risk management process – from inputs to reports to report analysis and actions. Basic Ingredients: Controlling the quality of inputs is essential. Garbage in – Garbage out! Very important and often overlooked part of the input is the assumptions. Is the data we use relevant for our calculations? What is the time horizon and data frequency that we use? Often the risk metrics in the portfolio calculated using last two months worth of data can be completely different from the risk metrics we get using two years worth of data. Juxtaposing those results, the risk manager can learn a lot about the portfolio and its potential behavior under stress. Then the risk manager would have to make a call what kind of data is more relevant going forward and use this set of assumptions. Shaping It: Short, digestible reports with few well analyzed metrics, should be run routinely. Like the portfolio manager has to run a fairly concentrated portfolio or securities market offers a lot of choices for investments, the risk manager has to focus on handful of relevant risk metrics, but understand them very well. Such metrics may include: Portfolio’s long, short and net exposure Portfolio’s breakdown by sector, region, strategy, asset type Largest single-name exposures Most significant risk factors and portfolio’s exposure to them (measured as betas or P&L to given scenarios) P&L to historical or potential future scenarios VaR and its variations, Greeks (when applicable) Liquidity metrics, cash reserves Portfolio performance metrics, performance attribution and comparison with market indices Qualitative information Routine is very important for risk management. If a metric is not calculated at least weekly, it should not be calculated at all, as there would be not enough history to compare the dynamic of the metric, and there would be not enough scrutiny in the process and calculations to trust the numbers. Baking It: Once the data is here, it is important to analyze it, digest it and act upon it. Turning information into knowledge is the key. One of the more difficult parts often is testing the assumptions that lead to the present portfolio composition. Those assumptions are often of two types: “It is going to be just like the last time” or “This time it is going to be different”. So it is important that risk manager asks those questions systematically and says “What is this time that is different? How it can be different?” or “Why do we think that this time it is different and what happens to our portfolio if turns out to be just like the last time?” The right question always contains at least 50% of the answer. It is also important to remember that only accumulating the risk data over a period of time can help us to see the changes in the numbers and then track those changes down to (sometimes undesired) changes in the portfolio.
This slide is a summary of previous several slides. It slide illustrates the similarities and differences between portfolio management and risk management. Often those roles are positioned as antagonists. In reality, those roles are complimentary in many aspects and quite similar in other aspects, and having a good working team of PM and RM is very beneficial for the portfolio.
![RISK MANAGEMENT ,[object Object],[object Object],Several Lessons From the Crisis](https://image.slidesharecdn.com/rmthreelessonsslides-090930220523-phpapp01/85/risk-management-three-lessons-1-320.jpg)
![Introduction ,[object Object],[object Object],[object Object]](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)