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NGB - Conference january 14, 2000 Quantitative Risk Management A (un-)biased Analysis

NGB - Conference january 14, 2000 Quantitative Risk Management A (un-)biased Analysis. Guus Boender ORTEC, VU, EUR. ORTEC Consultants bv Erasmusstaete Max Euwelaan 78 Brainpark 1 P.O. 4074 3006 AB Rotterdam. Tel.: 010 4986666 Fax: 010 4986667 email: gboender@

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NGB - Conference january 14, 2000 Quantitative Risk Management A (un-)biased Analysis

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  1. NGB - Conference january 14, 2000 Quantitative Risk Management A (un-)biased Analysis Guus Boender ORTEC, VU, EUR ORTEC Consultants bv Erasmusstaete Max Euwelaan 78 Brainpark 1 P.O. 4074 3006 AB Rotterdam Tel.: 010 4986666 Fax: 010 4986667 email: gboender@ rotterdam. ortec.nl

  2. Financial Modelling Successes: • Diversification / MPT* • Arbitrage / Option pricing* • VaR; RaRoC • SaR  ALM; EaR • State dependent risk policies Failures: • Leeson • Metalgesellschaft • Collapse Asia • LTCM • MPT Volkskrant “Deception of the public” “Lies, Big Lies and Statistics” “Unforeseeable risks”

  3. ? What is going on here, and what can we learn from an analysis for successful financial modeling

  4. Modelbuilding: Art or Science ? Best Model of Reality = Reality Itself Modelbuilding = Trade-off - Description Reality - Tractability (sim/opt)

  5. Models: Objectives I Description of Reality (knowledge base) II Insight, New Insights, Awareness III Beat the Market, Computer Trading, Automatic Risk Control

  6. Models: Fallacies • Suppose: • Mean reversion scenarios of interest rates: mean 5% • Duration policy: • “short” at interest rates below 5% • “long” at interest rates above 5% • Question: • Would the scenarios prove this duration policy • to be superior to a fixed duration policy ?

  7. Inflation Hedge Equity? • 1-year correlation: 15%. • Boudoukh and Richardson Stock returns and Inflation: A long-Horizon perspective; The American Economic Review 200 years data: 5 years correlation: 40% !

  8. Failure and Success Factors • Failure: • Overestimating the reality-ratio of the model • Insufficient “model-education” of decision makers • Partial models of an organisation • Black box • Succes: • Insights, New Insights Open box • “Model-education” of decision makers • Integral model of an organisation • Open box

  9. FUTURE Massive growth of enterprise wide risk management: • Not only in banks, pension funds etc, but also in oil-, airline-, software industries etc, and also for individuals: On Internet • Much more new financial products (derivatives) to reduce and trade risks: • Inflation risks for pension funds and housing corporations • Inflation risks for pension funds or individuals and the central government

  10. FUTURE • Much more effort of the model-builders in explaining the assumptions of the models to the decision makers • Much more effort in better modelling of risk factors: • Longer term relationships • State dependent quantities, such as Correlations and Risk Premia of Equity • Impact of demand- and supply factors on interest rates and the prices of equity OUR FUTURE IS BRIGHT

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