Lesson 6 of 8 · All lessons in this module
- Risk, risk exposure and what risk management is
- The risk management framework
- Risk governance and the enterprise view
- Risk tolerance and risk budgetingVideo lesson
- Financial and non-financial risks, and how they interact
- Risk drivers and risk metrics
- Modifying risk: avoid, accept, transfer or shiftVideo lesson
- Integrated case: hedging the currency of a foreign bond holding
Lesson 6 of 8 · 14 min
Risk drivers and risk metrics
Risk is driven by macroeconomic, industry and company factors, and it is measured with metrics suited to each exposure, from probability and standard deviation to beta, duration, the Greeks and value at risk, supplemented by scenario analysis and stress tests.
In short
- Risk drivers: global and domestic macroeconomies (shaped by governments and central banks), industries, and individual companies. Some can be influenced, many cannot.
- Probability alone is not a sufficient risk metric. Standard deviation describes dispersion but may mislead for fat-tailed, non-normal returns.
- Beta measures market (systematic) risk added to a diversified portfolio; duration measures interest rate sensitivity.
- Derivative risk: delta (small moves in the underlying), gamma (change in delta; large moves), vega (volatility), rho (interest rates).
- VaR: a minimum loss over a period with a given probability; three elements (amount, time period, probability). Not the maximum loss. CVaR averages the losses beyond VaR.
- Supplements: scenario analysis, stress testing, extreme value theory. Credit (ratios, probability of default, expected loss given default, credit VaR) and operational risks are hard to measure because the events are rare, so they rely on grouping similar firms and on pooled loss data.
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