Chapter 43: The Risk Management Process (2) Flashcards
Risk Measures:
- Asset risks
Active risk measures include historic tracking error and forward-looking tracking error.
Risk Measures:
- Liability risks
These are commonly measured by carrying out an analysis of actual vs expected experience.
Risk Measures:
- Value at Risk
Value at Risk represents the maximum potential loss on a portfolio over a given future time period with a given degree of confidence.
Risk Measures:
- Expected Shortfall
The expected shortfall is the expectation of losses below a certain level. If the specified level is a percentile point on the distribution then this is called the Tail VaR.
The Tail VaR could also be defined as the expected shortfall, conditional on there being a shortfall.
3 Steps of scenario analysis
- grouping of risks into broad categories
- development of adverse scenario for each risk group
- calculation of consequences of risk event occurring for each scenario
- total costs calculated are taken as the financial cost of all risks represented by the chosen scenario.
Stress testing
Involves testing for weaknesses in a portfolio by subjecting it to extreme market movements.
2 Types of stress test
- to identify “weak areas” in the portfolio and investigate the effects of localised stress situations by looking at the effect of different combinations of correlations and volatilities.
- to gauge the impact of major market turmoil affecting all model parameters, while ensuring consistency between correlations while they are “stressed”
The Stochastic model is often limited by one of the following approaches: (3)
- restrict the duration (or time horizon) of the model
- limit the number of variables modelled stochastically, use a deterministic approach for the other variables
- carry out a number of runs with a different single stochastic variable and then single deterministic run using all the worst case scenarios together.
Reporting on risk
It is usual to report on risk by quantifying the capital requirements to protect against ruin at a particular ruin probability.
5 Main issues facing providers of financial benefits in completing the assessment
- Should the ruin probability be expressed over a single year or whole run-off of business?
- A stochastic model with more than 2 stochastic variables is impractical, so it may be better to use a correlation matrix instead.
- Interactions between risks should be dealt with.
- Some risks, particularly operational, are highly subjective
- Using past data to estimate future consequences needs to be undertaken with caution.
3 Ways in which to deal with low probability, high impact risks
- They can only be diversified in a limited way
- can be passed to an insurer or reinsurer, usually by some form of catastrophe insurance or whole account aggregate excess of loss cover (commonly called “stop loss” cover)
- can be mitigated by management control procedures, such as disaster recovery planning.
Risk portfolio
The risk portfolio categorises the various risks to which the usiness is exposed.
Against each risk would be a recorded quantification of:
- – impact
- – probability
The risk portfolio can be extended to indicate how the risk as been dealt with: (4)
- retained (and how much capital is needed to support it)
- transferred
- mitigated (and a revised assessment of the remaining risk)
- diversified (and a revised assessment of the remaining combination of risks)
The most common way of measuring liability risks
The analysis of experience
Analysis of experience
The ratio of the actual occurrences of an event to the expected occurrences when the risk was accepted.