Tuesday, July 6, 2010
A balanced approach to risk
Because risk is so difficult to get ones arms around, it needs to be approached from multiple directions, so as to get the best picture possible of what we're facing. In addition to typical risk measures such as standard deviation, tracking error, and beta, and risk-adjusted measures such as Sharpe ratio, Information ratio, and M-squared, we should consider other aspects of risk, too.
In spite of its challenges, Value at Risk (VaR) provides us useful information. Liquidity risk is another measure one should be assessing. At last month's PMAR Europe, Jose Menchero discussed "extreme risk," which can be seen as a complement to VaR.
Failing to properly assess risk is risky: looking at it from multiple angles is one way to gain some insights into what's going on.