Crash of 2008/Tutorials: Difference between revisions
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===''Tail risk''=== | ===''Tail risk''=== | ||
<ref>[http://www.world-economics-journal.com/Contents/ArticleViewer.aspx?ID=341 Andrew Haldane: "Risk-Pricing and the Sub-Prime Crisis", ''World Economics'' July-September 2008]</ref> | An explanation for risk-management errors that has been put forward by Andrew Haldane (Head of the Bank of England's Systemic Risk Assessment Department) <ref>[http://www.world-economics-journal.com/Contents/ArticleViewer.aspx?ID=341 Andrew Haldane: "Risk-Pricing and the Sub-Prime Crisis", ''World Economics'' July-September 2008]</ref> suggests that they arose from investors' and rating agencies' use of linear models based upon the CAPM ''(Capital Asset Pricing Model)'' <ref> See paragraph 2.3 of [[Financial economics]]</ref>. Such models assume that risks can be represented by the symmetrical bell-shaped [[normal distribution]], and can give inaccurate results if the true distribution has a "fat tail", as a result of which there is a significant additional ''tail risk''. Earlier work by Raghuram Rajan | ||
<ref>[http://faculty.chicagogsb.edu/raghuram.rajan/research/finrisk.pdf Raghuram Rajan: ''Has Financial Development Made the World Riskier?'' , Working Paper No 11728, National Bureau of Economic Research September 2005]</ref> suggests that securitised assets may be expected to involve significant tail risks. Since the events involving such risks are by definition rare, they cannot be expected to be picked up by models based upon a five or six years' run of data. | |||
<ref>[http://faculty.chicagogsb.edu/raghuram.rajan/research/finrisk.pdf Raghuram Rajan: ''Has Financial Development Made the World Riskier?'' , Working Paper No 11728, National Bureau of Economic Research September 2005]</ref> | |||
==References== | ==References== | ||
<references/> | <references/> | ||
Revision as of 05:51, 5 November 2008
Risk-management errors
- (for definitions of the terms shown in italics on this page see the glossary on the Related Articles subpage [[1]]
Tail risk
An explanation for risk-management errors that has been put forward by Andrew Haldane (Head of the Bank of England's Systemic Risk Assessment Department) [1] suggests that they arose from investors' and rating agencies' use of linear models based upon the CAPM (Capital Asset Pricing Model) [2]. Such models assume that risks can be represented by the symmetrical bell-shaped normal distribution, and can give inaccurate results if the true distribution has a "fat tail", as a result of which there is a significant additional tail risk. Earlier work by Raghuram Rajan [3] suggests that securitised assets may be expected to involve significant tail risks. Since the events involving such risks are by definition rare, they cannot be expected to be picked up by models based upon a five or six years' run of data.