Question

1. What statistical measure do we initially use for the relevant or non-diversifiable risk?

Answer 1

Risk management is divided into two broad categories: systematic and unsystematic risk.

Systematic Risk

Systematic Risk is associated with the market. This risk affects the overall market of the security. Generally these these risk are uncontrollable.These are unpredictable and undiversifiable; however, the risk can be mitigated through hedging. For example, political upheaval is a systematic risk that can affect multiple financial markets, such as the bond stock, and currency market.Corona lockdown is another example of systematic risk .it affects the whole market activity, economic activities both allover the world.

Unsystematic Risk

The second category of risk, unsystematic risk, is associated with a company or sector. It is also known as diversifiable risk and can be mitigated through assets diversification. This risk is only inherent to a specific stock or industry. If an investor buys an land he assumes the risk associated with both the real estate industry and the company itself

Statisticals measures for calculating non diversified risk

• Standard Deviation

Standard deviations measures the dispersion of data .The standard deviation is used in making an investment decision to measure the amount of historical volitality associated with an investment relative to its annual rate of return. For example, a stock that has high standard deviation experiences higher volatility, and therefore, a higher level of risk is associated with the stock.

• Beta

Beta is another common measure of risk. Beta measures the amount of systematic risk an individual security or an industrial sector has relative to the whole stock market. The market has a beta of 1, and here B is beta if B>1,there is more volitality in the market .If B<1,it means less volitality in market.. if B=1 then the security price move in the market ina step time.

• Value at Risk (VaR)

This statistical measure associated with the portfolio of the company. The VaR measures the maximum potential loss with a degree of confidence for a specified period. For example, suppose a portfolio of investments has a one-year 12 percent VaR of $20million. Therefore, the portfolio has a 12 percent chance of losing more than $20 million over a one-year period.

• Conditional Value at Risk (CVaR)

is another risk measure used to assess the tail risk of an investment. Used as an extension to the VaR, the CVaR assesses the likelihood, with a certain degree of confidence, that there will be a break in the VaR; it seeks to assess what happens to investment beyond its maximum loss threshold. This measure is more sensitive to events that happen in the tail end of a distribution—the tail risk. For example, suppose a risk manager believes the average loss on an investment is $30 million for the worst three percent of possible outcomes for a portfolio. Therefore, the CVaR, or expected shortfall, is $30 million for the three percent tail.