Market Risk Control Techniques

Question 1

How can market risk be controlled?

Answer 1

1. Using VaR models - predicted loss at a specific confidence level over a given time period.
2. Using Expected Shortfall - looks at the average loss that could occur in excess of the loss calculated by VaR.
3. Stress testing and scenario analysis
4. Market risk reporting - balance sheet positions, reason for the positions, VaR, stress test results, current profit/loss status.
5. Hedging - Matching a position with an equal and off-setting position in a financial instrument that tracks or mirrors the value changes in the position being held.

Question 2

What is basis risk?

Answer 2

The risk that the instrument being used for hedging purposes does to perfectly correlate with the investment.