Financial Risk Meter Most Important for Business
Financial risk is characterized by a quantitative risk. If the business has brought up the right tools to use.
But if the tools to measure financial risk are not good The results obtained from the measurements may have been terribly wrong. and may eventually lead the business to a financial crisis
proper measurement concept
Financial risk management is no different from the management of other parts of an entity. is to recognize the size of the risk first So they can decide how to deal with that risk.
Measuring the magnitude of risk is beneficial to an entity only if the appropriate tools are available to measure the magnitude of the risk. and lead to further analysis and evaluation of appropriate management practices
Before managing financial risks Therefore, the business must answer the question whether Has the current situation been taken into account? And after considering it, can you believe it or not? The method or instrument used to measure the financial risk an entity is using. or to be used that is appropriate
Appropriateness of financial risk sizing tools is that the instrument can adequately describe what is to be measured. correct and complete
in case of financial risk The risk measurement model is ineffective when a given situation or assumption is no longer true.
Issues to consider in terms of definitions
Things to consider when measuring the size of financial risk Especially in the case of financial institutions is
- Unsure of how to define risk
- There are many different definitions of risk.
Risk is the maximum risk of loss (Maximum Loss) at a given level of probability (Given Probability) is the loss from holding an asset portfolio (Asset Portfolio) within a certain period of time. considering and wanting to measure the size of the risk
Risk is the maximum size of the loss that will occur. as a result of holding an asset within a given period of time and wanting to measure the size of the risk not limited by any degree of possibility
Value at Risk
General entities will choose to use either of the two definitions above, in which case the first definition is to use Value at Risk : VaR as a measure.
VaR is a limited tool: it considers risk only as a variance as a percentage of the average outcome (Average or Mean), which is limited because it does not consider extreme damage. Outcomes)
With this constraint, many entities are stuck in the past with the average. I don’t believe that this will happen to extremes. Ignoring the 1 in 10 or 20 year chance
The benefit of using VaR as a risk measurement tool is that it initiates the process of measuring and assessing the risk prior to the addition of other measurement tools.
another is Finding information on extreme situations is difficult. Because it may not have a history in the past before. So I don’t know how much difference or distance from the mean or the mean. to be able to use other tools There must be methods and principles for establishing the assumptions of the situation and obtaining the data for reliable determination.
In addition, most businesses, especially financial institutions, do not pay much attention to the overall risk measurement of all assets. and the components of every port over
Modified conditional relationship
In businesses or financial institutions with large and complex portfolios that want to measure the size of their portfolio risk What it takes is a matter of the maximum possible loss size.
The purpose of this measure of risk It doesn’t care about the losses of individual portfolios that are composed of similar assets only. but also interested in the loss that comes from the relationship and the relationship of each port as well. This may be called Dynamic Conditional Correlation : DCC, which is the case of extreme situations in the financial markets.
In this case, the entity assumes that Each port is related to the overall presence in the entity’s financial statements. and unique port changes also has a relationship to the change of other ports to change inconsistency The business must find a way to recognize these conditions.
The meaning of this new concept is The extreme case of the situation does not depend on the person being able to clearly draw a graph. because it will change continuously (Dynamic)
Each risk measurement may therefore require a 5 or 7 alternative assumption (Standard Duration) of variance. instead of using a single assumption
The use of adaptive tools in this regard is also a challenge for enterprises. especially in the
Describing an event or risk situation
- Determining the control point that should initiate additional actions if the change process begins to have a trigger that affects the entity.
- Identifying how a relationship has changed from an existing relationship in a given situation
- This DCC point is widely used to measure the size of market liquidity. So-called Liquidity Black holes are believed to influence the dynamics of the relationship between asset portfolios.
Measuring Risk with Scenario Analysis
Since a lot of history does not repeat itself, many events in the financial markets do not repeat the same. As a result, the business turned more attention to Scenario Analysis by creating a scenario for testing risk situations in advance, especially stress testing.
However, there is no statistical validation method that can measure the validity of the generated scenario, i.e. it is not possible to determine the validity of the likelihood or hypothesis created with this method.
Besides that, the Scenario should be built on the management level. Board of Directors or a corporate governance agency because it will be consistent with the objectives and missions of the organization More than the operational level and is also easy to adjust to be flexible according to the risk profile and business model of each entity. to be useful for business planning and the allocation of resources, budget or even capital funds according to risky assets
The entity will refer to each scenario as a special situation and determine how it is likely to affect its operations. And how should a backup plan be in place?