Module 14 - Introduction to risk measurement

Question 1

Axioms of risk coherence for risk measures (4)

Answer 1

Monotonicity - more capital for more loss
Subadditivity - capital for two departments independently is the maximum required if the departments are brought together
Positive homogeneity - Two departments merging is equal to two independent departments capital
Translation Invariance - If you add to a loss, capital required required is reduced by the same

Question 2

Types of deterministic risk measurement techniques

Answer 2

Notional - weight for assets
Factor sensitivity - the effect of a change to interest rates for example
Scenario sensitivity - range of factor sensitivity tests at once

Question 3

Five probabilistic risk measurement techniques

Answer 3

Deviation
Probability or ruin
VAR
Tail VAR
Expected shortfall

Question 4

Advantages and disadvantages of VAR

Answer 4

Advantages
Easy to calculate
Intelligibility of units i.e money
Applicable to a wide range of risks
Applicable to a wide source of risks
Easy to use translate into a benchmark/risk limit

Disadvantages
Not applicable to skewed distributions
Sensitive to Parameters, data and distributions must be correct
Underestimate assymetric and fat tailed distributions
Use in regulation might lead to herding
Doesn’t show the magnitude of loses if they occur
Not always sub-additive

Question 5

VAR is based on 3 basic factors

Answer 5

Exposure
Liquidity - time horizon
Price volatility factor