Market risk in financial sector
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Ημερομηνία
2015-03-23
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Kalantzi Alexia, 2011, Market risk in financial sector : value at risk (VaR) and systematic risk, Master's Dissertation , international Hellenic University
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Market risk is normally associated with instruments traded on well defined markets,
though increasingly, techniques are used to assess the risk arising from over the
counter instruments, and/or traded items where the market is not very liquid. The value
of any instrument will be a function of price, coupon, coupon frequency, time, interest
rate and other factors. If a bank is holding instruments on account (for example
equities, bonds), then it is exposed to market risk, the risk that the price of the
instrument will be volatile. Systematic market risk is caused by a movement in the
prices of all market instruments because of, for example, a change in economic policy.
Unsystematic market risk arises in situations where the price of one instrument moves
out of line with other similar instruments, because of an event related to the issuer of
the instrument.
Value at risk (VaR) has become the standard measure that financial analysts use to
quantify market risk. VaR is defined as the maximum potential change in value of a
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portfolio of financial instruments with a given probability over a certain horizon. More
specific, it is the maximum loss which can occur with X% confidence over a holding
period of n days. The results produced by a VaR model are simple for all levels of staff
from all areas of an organization to understand and appreciate. That is why VaR has
been adopted so rapidly.
Increased volatility of financial markets and rapid enhancement of computer systems
gave banks an important characteristic. Bank would now be a risk manager compared
to their former “traditional” role. The science of risk management is not a mature field
of knowledge but it constantly evolves. The most prominent of risks – on which a bank
is exposed – is market risk since it reflects the potential economic loss caused by the
decrease in the market value of a portfolio. Value at Risk (VaR) is the most common
measure that financial analysts, banks and supervisors use to measure market risk.
The concept of systematic risk has played an important role in finance since Markowitz
formalized the notion that investors should hold a diversified portfolio under
uncertainty. There have been lots of financial studies concerning beta coefficient: its
estimation has “traditionally” been achieved by running a market model regression. Is it
important for a company and the investor too? What about the stability of beta and its
behavior in bull and bear markets? May the downside risk, as measured by the beta
corresponding to bear market, be an appropriate measure of portfolio risk? All of these
questions and more other will be answered, in order to be clarified, after reading the
paper, what market risk is, which are the specific risks that modern banks have to
measure, what Value at Risk is and how we can use it to measure all of these risks,
what other types of risk measurement exists, what beta coefficient is and what
systematic risk is.
On this project the VaR approach and the most popular coefficient in finance, beta,
will be presented while trying to analyze market risk, on which a bank is exposed. Beta
coefficient of five Greek banks’ stocks will be defined in bull and bear markets using
Ordinary Least Squares regression (OLS). The VaR of a hypothetical portfolio will be
also estimated using “beta model” and will be compared to the variance – covariance
method.