Reading 41: Risk Management - Introduction (Risk management framework…
Reading 41: Risk Management - Introduction
: is the process of
Identifying and measuring the risks that an organization (or portfolio manager, or individual) faces.
Determining an acceptable level of overall risk (establishing risk tolerance)
Deciding which risks should be taken, and which should be reduced or avoided.
Putting the structure in place to maintain the bundle of risks that is expected to best achieve the goals
Risk management framework features
Identify and measure existing risks
Determine the organization's overall risk tolerance
Establish the processes and policies for risk tolerance
Manage and mitigate risks to achieve the optimal bundle of risk
Monitor risk exposure over time
Communicate across the organization
Performing strategic risk analysis
: Senior management's determination of the organization's risk tolerance, the element of its optimal strategy, and the framework for oversight of the risk management function
is the overall amount of risk that an organization will take in pursuing its goals.
is determined by top management.
is the process of allocating the total risk the firm will take to assets or investments
Risk budgeting consider the risk characteristics of each and how they can be combined to best meet the organization's goals.
Sources of risk
those that arise from exposure to financial markets, including credit risk, liquidity risk, and market risk
risks from the operation of the organization and from external sources.
Interaction among risks are frequent and can be especially significant during period of stress in financial market.
Measures of Risk Exposure
Derivative risk measures include delta, gamma, vega and rho.
Tail risk is measured with Value at Risk (VaR) or conditional VaR
Risk of assets is measure by standard deviation, beta, or duration.
Some risks must be valued subjectively
Risk Exposure Modification
Organization may bear a risk (self-insurance), avoid or take steps to prevent a risk, efficiently manage a risk through diversification, transfer a risk with insurance or a surety bond, or shift a risk (change the distribution of uncertain outcomes) with derivatives
Organization may use multiple methods of risk modification after considering the cost and benefit of the various methods.
The end result is a risk profile that match the organization's risk tolerance and includes the risks that top management has determined match the organization goal