- Risk modeling
Risk modeling refers to the use of formal
econometric techniques to determine the aggregate risk in a financial portfolio. Risk modeling is one of many subtasks within the broader area offinancial modeling .Risk modeling uses a variety of techniques including
market risk , Value-at-Risk (VaR ),Historical Simulation (HS), or Extreme Value Theory (EVT) in order to analyze a portfolio and make forecasts of the likely losses that would be incurred for a variety of risks. Such risks are typically grouped intocredit risk ,liquidity risk ,interest rate risk , andoperational risk categories.Many large financial intermediary firms use risk modeling to help portfolio managers assess the amount of capital reserves to maintain, and to help guide their purchases and sales of various classes of financial assets.
Formal
risk modeling is required under theBasel II proposal for all the major international banking institutions by the various national depository institution regulators.Quantitative risk analysis and modeling have become important in the light of
corporate scandals in the past few years (most notably, Enron),Basel II , the revised FAS 123R and theSarbanes-Oxley Act . In the past, risk analysis was done qualitatively but now with the advent of powerful computing software, quantitative risk analysis can be done quickly and effortlessly.See also
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Financial risk management
*Knightian uncertainty
*Financial modeling References
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* Machina, Mark J., and Michael Rothschild (1987). "Risk," "", v. 4, pp. 201-206.
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