Measurement of Risk in Financial Management

ChartClick to enlarge
Source: Institute for New Economic Thinking

NYU prof Robert Engle, who long-time blog readers may recall from this post a ways back, won the Nobel prize for his work on Volatility.

He has developed new ways to measure “Systemic risk” from his perch at the Volatility Institute at NYU:

“We estimate the amount of capital that a financial institution would have to raise in order to continue to function normally if we have another financial crisis like the one in 2008. This is interpreted as a capital cushion to protect against a decline of 40% in the broad equity market over the six months after this occurs . . .
We call this measure SRISK.US Fin by SRISK We compute it weekly and post it on the website ‎systemicrisk. The estimation uses equity prices with methods that are extensions of the volatility models that formed the basis for my Nobel Prize. SRISK combines information on size, leverage, and risk to indicate how serious a default would be.

As the chart above shows, Lehman was not the only one who had engaged in too much risk taking. Indeed, they were not even the worst offender. And as the table below shows, JP Morgan now represents the greatest risk to the financial system.

Princeton University Press The Known, the Unknown, and the Unknowable in Financial Risk Management: Measurement and Theory Advancing Practice
Book (Princeton University Press)

The culprits

2008-10-04 12:24:48 by -

Derivatives have permitted financial risks to be unbundled in ways that have facilitated both their measurement and their management...As a result, not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient."
~~Alan Greenspan, May 2003
"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage."
~~Alan Greenspan, February 22, 2004
"The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and

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