CH:29 Risk measurement and reporting

Question 1

What are the 2 key features to be assessed for all risk event?

Answer 1

• probability of event occurring
• expected loss if the event occurs

Question 2

What are the 2 typically used approaches to allow for operational risk with an organisation?

Answer 2

• broad-brush approach that does not need any detailed analysis
• scenario analysis

Question 3

What are the steps in scenario analysis

Answer 3

• risk exposures need to be grouped into catergories eg, all risks involving financial fraud
• for each group of risks, a plausible adverse scenario is developed
• for each scenario, the organisation must translate the scenario into assumptions for the various risk factors in the model
• the total costs calculated are taken as the financial cost of all risks represented by the chosen scenario

Question 4

Define stress testing

Answer 4

financial stress test is a projection of the financial condition of a company under a specific extreme adverse event over a period of time.

Question 5

How can individual risks be aggregated to allow for correlations and inter-actions

Answer 5

• stochastic modelling
• simple formulae if risk events are fully dependent or fully independent
• correlation matrices
• copulas- functions that take as inputs marginal cumulative distribution functions and output a joint cumulative distribution functions

Question 6

Define Copulas

Answer 6

A copulas is a function, which takes as inputs marginal cumulative distribution functions, and outputs a joint cumulative distribution function

Question 7

What are the 2 groups that risk measures can be classified into ?

Answer 7

• Deterministic - measures are simplistic, giving a broad indication of the level of risk
• Probabilistic - measures are potentially more accurate, but they are more complex, and can imply inappropriate levels of confidence

Question 8

What are the probabilistic approaches to measuring risk

Answer 8

• deviation (including standard deviation and tracking error)
• Value at Risk
• probability of ruin
• Tail Value at Risk

Question 8

What are the 3 deterministic approaches to measuring risk

Answer 8

• notional approach - broad-brush risk measure eg, application of risk weightings to the market values
• factor sensitivity approach - determines the degree to which an organisation’s financial position is affected by the impact that a change in a single underlying risk factor eg, short-term interest rates
• scenario sensitivity approach - similar to factor sensitivity but rather than changing a single underlying risk factor, the effect of changing a set of such factors

Question 9

What does regular risk reporting allow management of the business to do

7

Answer 9

• identify new risks faced by the business
• obtain a better understanding of the risks faced by the business
• determine appropriate risk and control systems to manage specific risks
• proactively monitor and manage the effectiveness of risk and control systems
• assess whether the risks are changing over time
• assess interaction between individual risk
• appropriately price, reserve and determine any capital requirements