Risk Measures Flashcards
When conducting mean-variance analysis, how is risk defined?
Risk is the volatility of the returns and volatility equals standard deviation of returns.
What does it mean when the variance is high in value?
The more variable the asset’s return distribution is, and the more risky the asset will be.
Downside Semi-Variance
Looks at what happens below the mean return. So only looks at the “bad” outcomes
Value-at-Risk
Risk based upon a given percentile or quantile
Tail-Value-at-Risk
The expected loss given that the loss is beyond the calculated percentile. The average of the losses in the worst x% of the probability distribution function for the outcome you are measuring
What is the limiting factor of Tail-Value-at-Risk?
Assumes you fully know the underlying distribution of the tail scenarios in order to calculate the TVaR. The outcomes are often higher than what was initially believed to be the worst possible outcomes
Why is the Monte Carlo Simulation useful for complex products?
It allows us to forecast a probability distribution function made up of all possible combinations of model variables in an aggregate framework. Can estimate the VaR, TVaR, or any risk measure.
Concerns with Monte Carlo Simulation
Depends on the assumed underlying probability distributions and correlations you used for your variables which are difficult to measure. Have to have good assumptions
How does Monte Carlo Simulation differ from deterministic analysis?
Deterministic analysis involves a “single point estimate” illustrating the outcome of one trial at a time. While Monte Carlo simulation allows us to see all possible outcomes of a decision to better assess risk.
Stochastic Modeling
A random number generator is used to stimulate a distribution of values
Advantage of TVaR over VaR
The VaR risk measure does not measure how bad the results can get if the outcome is beyond so TVaR helps overcome this disadvantage because it measures expected loss given that the loss is beyond a certain threshold.
