Crash of 2008/Tutorials: Difference between revisions
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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 (Director of Research at the International Monetary Fund) securitised assets may be expected to involve significant tail risks. | 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 (Director of Research at the International Monetary Fund) suggested that securitised assets may be expected to involve significant tail risks. | ||
<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> . 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> . 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. | ||
Revision as of 09:09, 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 (Director of Research at the International Monetary Fund) suggested that securitised assets may be expected to involve significant tail risks. [3] . 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.