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| Monte Carlo Simulation and VAR |
Market risk has evolved over the courses of the last 20 years and moved from a very simplistic approach to a sophisticate one. Back in the early 1980s, risk management was still considered by some to be the backwater of financial services, a place for ex-traders or people who wanted to be traders.
Then came the Black Monday stock market crash of October 19, 1987. In a single day, the Dow Jones Industrial Average lost 22.61% of its value - its largest one-day drop for more than 70 years. Portfolio insurance and program trading were initially blamed for the drop - factors that were little understood by bank senior management. All of a sudden, risk management's stock had risen.
Today, Risk management is no longer just an afterthought, primarily aimed at satisfying the regulators. Rather than being locked away in a cubbyhole somewhere, risk managers are now often situated on or close to the trading floor. They play a key part in the investment process and group strategy as a whole. And weak risk management processes can now negatively affect a firm's share performance. Perhaps most tellingly, risk management is now no longer just a job for ex-traders - it's a real career and attracts the very brightest from the quant community.
Market risks refers to changes in the value of financial instruments or contracts held by a firm due to unpredictable fluctuations in prices of traded assets and commodities as well as fluctuations in interest and exchange rates and other market indices.
Banking supervisors have taken a special interest in codifying risks and in setting standards for their assessment. Their purpose is essentially prudential: to strengthen the soundness and stability of the International banking system whilst preserving fair calculations of risk sensitivities. |
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