The possibility that a negative event (such as a loss) will happen.

learn more… | top users | synonyms

6
votes
1answer
376 views

What distribution should I apply to estimate the likelihood of extreme returns?

Say I have a limited sample, a month of daily returns, and I want to estimate the 99.5th percentile of the distribution of absolute daily returns. Because the estimate will require extrapolation, I ...
10
votes
4answers
2k views

What is a “coherent” risk measure?

What is a coherent risk measure, and why do we care? Can you give a simple example of a coherent risk measure as opposed to a non-coherent one, and the problems that a coherent measure addresses in ...
3
votes
3answers
420 views

Why should there be an equity risk premium?

After years of mathematical finance I am still not satisfied with the idea of a risk premium in the case of stocks. I agree that (often) there is a premium for long dated bonds, illiquid bonds or ...
9
votes
4answers
1k views

Is the risk-free rate really limited by inflation?

In all the classic texts on equities derivatives, there is an assumption of the risk-free rate r. We can immediately dismiss the concept of a fixed rate; all interest rates are variable (and ...
8
votes
1answer
38 views

What are useful indexes for rapid evaluation of country economic risk?

The World Economic Forum Global Competitiveness Report offers a comprehensive view of individual country risk/reward. There has been an explosion of these types of indexes over the past few years. ...
14
votes
4answers
2k views

How are risk management practices applied to ML/AI-based automated trading systems

A potential issue with automated trading systems, that are based on Machine Learning (ML) and/or Artificial Intelligence (AI), is the difficulty of assessing the risk of a trade. An ML/AI algorithm ...
4
votes
1answer
1k views

Performance Attribution : Annualizing alpha & factor return contributions

Let's say I have a factor model which I am using for Performance Attribution. I'd like to separate returns from alpha vs. returns from exposure to various risk factors. For each date, the factor ...
9
votes
1answer
644 views

How are Expected Shortfall and Variance related?

I would like to know how Expected Shortfall $SF_\alpha$ and variance $\sigma^2$ are related. If I follow what Aaron Brown answered in this post, when the underlying distribution is Normal with ...
9
votes
2answers
799 views

What is the relationship between risk aversion and preference for skewness and kurtosis in portfolio optimization?

Is there any relationship between the risk aversion coefficient in an individual's utility function (commonly used in portfolio optimization) and the preference for higher moments such as skewness and ...
5
votes
1answer
143 views

Are there quantitative models which can guide one's choice of target risk?

Note: This question was written for the weekly topic challenge. Many asset allocation funds presume the investor knows his target risk level, typically on some spectrum from conservative (mostly G7 ...
7
votes
2answers
1k views

How to apply risk-parity portfolio construction to a dollar-neutral portfolio?

Long-only risk-parity portfolios have proliferated in recent years. An optimized long-only risk-parity portfolio requires that the asset weight * marginal contribution to risk of the asset is ...
9
votes
1answer
678 views

Models for measuring insurance risk exposure

I've recently begun working as a quant for a large bank, and one of my first tasks will be to improve the model determining the risk exposure of their insurance portfolio. The portfolio is fairly ...
9
votes
0answers
325 views

performance of historical VaR parameters

An historical VaR measure is parameterized in terms of the confidence level and also number of periods. Specifically, the $\alpha$% T-period VaR is defined as the portfolio loss x in market value over ...
1
vote
0answers
232 views

How would I calculate a stop on a pair trade? [closed]

I have a trading strategy that I use on single tickers. I'd like to start using it with pairs as well. However, I'm somewhat math challenged and not sure how to best calculate the stops of the ...
4
votes
2answers
418 views

Choice of prior as a shrinkage target in portfolio construction?

There's various research showing how priors such as the minimum variance portfolio turn out to be a surprisingly effective shrinkage target in portfolio construction. The sell point of these priors ...
8
votes
1answer
680 views

How to compute modified-CVaR in the PerformanceAnalytics package?

My objective is to measure the modified-CVAR for a portfolio given its weights and matrix of security returns. Luckily the wonderful package PerformanceAnalytics has an ES() function that does just ...
2
votes
0answers
520 views

How to Calculate Risk of Ruin [closed]

I'm reading a book titled "A Trader's Money Management System" and it discusses risk of ruin(ROR) tables. It says that you can have a zero probability of ROR with a payoff ratio of 2 to 1 and a win ...
6
votes
2answers
211 views

Is it better to grade hedging strategies based on the sum of absolute or squared hedging errors?

Let's say I have one strategy that has a hedging error of: 2, 2, -2, -2 Let's say I have another strategy that has a hedging error of .5, .5, 3, 3 Would it be a better idea to grade the hedging ...
4
votes
1answer
409 views

How to model the risk of a CFD

I'm struggling to understand why the risk on an equity CFD is not the same as for the corresponding equity. The RiskMetrics FAQ mentions two ways to model a CFD, but it does not explain why this is ...
5
votes
3answers
110 views

Which lags or percentiles should be run in a batch when calculating Value-at-Risk?

Are there any "standard" VaR calculations run in a batch? For example, testing a VaR calculation with a lag of 1,2, 5 or 10 days over 2 years? Same question for the percentile, 1%, 2.5%, 5% etc.
10
votes
2answers
790 views

When should you build your own equity risk model?

Commercial risk models (e.g., Barra, Axioma, Barclays, Northfield) have evolved to a very high level of sophistication. However, all of these models attempt to solve a very broad set of problems. ...
17
votes
2answers
688 views

How are distributions for tail risk measures estimated in practice?

Let's say you want to calculate a VaR for a portfolio of 1000 stocks. You're really only interested in the left tail, so do you use the whole set of returns to estimate mean, variance, skew, and shape ...
11
votes
2answers
3k views

How does left tail risk differ from right tail risk?

How does left tail risk differ from right tail risk? In what context would an analyst use these metrics?
7
votes
2answers
331 views

Do you know a good article on ETF's counterparty risk analysis?

I am at the moment considering investing into ETFs, but I am looking first to understand how these products really work. Indeed, it is my understanding that ETF can vary in terms of structure, thus ...
5
votes
4answers
793 views

Do low volatility stocks outperform high volatility stocks over the long run?

A recent article from Forbes seems to indicate that low volatility stocks outperform high volatility stocks over the long run. Does anyone have any supporting or contradicting evidence to this claim? ...
8
votes
4answers
691 views

What are the risk factors in analysing strategies?

What do you think of strategies displayed on timelyportfolio.blogspot.com? I really like the fact that there is some code to reproduce the strategies, but they seem very elementary because he does ...
16
votes
2answers
598 views

How do macro funds manage risk and model asset returns? Do they use factor models?

Some of the largest funds in the world are entirely macro-based: Soros, Brevan Howard, Bridgewater. They trade across asset classes, and seemingly with very concentrated allocations. What type of risk ...
5
votes
1answer
880 views

Value at Risk backtesting (kupiec)

I m doing my research on estimating Value at risk using different assumptions on volatility and then compare my results based on backtesting. I obtained results and just on question based on my ...
15
votes
1answer
992 views

Portfolio optimization with monte carlo sampling from predictive distribution

Let's say we have a predictive distribution of expected returns for N assets. The distribution is not normal. We can interpret the dispersion in the distribution as reflection of our uncertainty (or ...
7
votes
1answer
1k views

What is the basis risk between cash and futures government bonds?

I am currently working in a team responsible for maintaining a simple risk application for our bond desk and I am interested in knowing how to provide some sort of basic basis risk metric. Our desk ...
8
votes
2answers
2k views

Equity Risk Model Using PCA

I'm trying to build a simple risk model for stocks using PCA. I've noticed that when my dimensions are larger than the number of observations (for example 1000 stocks but only 250 days of returns), ...
22
votes
2answers
5k views

What is the difference between the methods for calculating VaR?

There are three different commonly used Value at Risk (VaR) methods: Historical method Variance-Covariance Method Monte Carlo What is the difference between these approaches, and under what ...
5
votes
1answer
4k views

Annualzing the log of daily returns riddle

Two popular ways to measure returns are Arithmetic returns and Log returns. Let's define arithmetic (simple period) returns as: P(t) - P(t-1) / P(t-1). Let's define log return as Ln( P(t)/P(t-1) ) or ...
8
votes
2answers
588 views

Minimizing Correlation

Is there a quantitative method in monitoring trades to reduce the possibility of correlated trades?
31
votes
5answers
2k views

Lévy alpha-stable distribution and modelling of stock prices.

Since Mandelbrot, Fama and others have performed seminal work on the topic, it has been suspected that stock price fluctuations can be more appropriately modeled using Lévy alpha-stable distrbutions ...
3
votes
2answers
773 views

Covariance for arbitrarily large portfolios

I am implementing a method in Java to calculate the variance, covariance, and value at risk for a portfolio, which should be flexible for use with any number of assets in a portfolio. I am struggling ...
2
votes
1answer
214 views

Picking from two correlated distributions

Can anyone provide a simple example of picking from two distributions, such that the two generated time series give a specified value of Pearson's correlation coefficient? I would like to do this in ...
8
votes
3answers
599 views

Price of Brent versus West Texas Intermediate

As of right now, the price of Brent Crude is $\$$111.59/bbl and the price of WTI Crude is $\$$98.36/bbl. I'm well aware that futures markets don't set the spot price for oil, but actual ...
10
votes
1answer
307 views

What approaches are there for stress testing a portfolio?

Wikipedia lists three of them: Extreme event: hypothesize the portfolio's return given the recurrence of a historical event. Current positions and risk exposures are combined with the historical ...