Webinar on the risks in the financial markets
The Centre for Accounting, Banking and Finance (CABF) together with the Department of Banking and Risk Management, Faculty of Business and Finance (FBF) organised a virtual talk titled “Risks in The Financial Markets” on 10 November 2022 via Microsoft Teams platform.
The webinar was delivered by Prof Dr Lim Kian Guan. Prof Dr Lim is the Professor of Quantitative Finance at Overseas Union Bank, and Chairperson at Lee Kong Chian School of Business, Singapore.
The objective of the webinar is to identify the sources of risk structuring the portfolio; measuring the risk including the coherent risk concept; differentiate between insurer and insured risks and develop a risk mitigation plan to reduce the impact of an unexpected event.
Prof Lim said, “Risk is any uncertain event that can affect a financial portfolio performance. Yet despite risk management, even the most well-constructed portfolio may deviate from its investment objective. The instruments traded in financial markets include stocks, bonds, currencies, commodities, and derivatives. Besides, these instruments are traded by retail investors and institutional investors such as banks, hedge funds, and insurance companies. These risks can be categorised as market risk, credit risk, operational risk, liquidity risk and others.”
Furthermore, Prof Dr Lim highlighted the portfolio performance measures used by investors to determine how their portfolio of assets are managed. "These performance measures are typically based on a financial economic equilibrium model and include CAPM, Treynor measure, Sharpe ratio, Jensen’s alpha and the Appraisal ratio. Other pervasive measures are the relative and absolute portfolio performance measures. Relative performance is the comparison of the portfolio returns against a suitable benchmark index such as S&P500, SPY ETF, and Salomon Broad Investment Grade Index for bonds. The absolute performance measure can also be compared to other funds and is useful for smaller and less diversified funds. He also mentioned the Sortino ratio which measures downside risk to determine the additional return for each unit of downside risk," he added.
Moreover, Prof Dr Lim commented that performance reporting gives investors the information they need to assess whether the funds' risk/reward relationships are appropriate to their needs. He also added that the ex-ante measures are used to make investment decisions while the ex-post measures are used to monitor performance; and the adjustments are then made to the portfolio and fund managers can be rewarded based on these measures.
Explaining the credit loss distribution as a form of risk management to identify possible risks, Prof Dr Lim stated, “The various elements of the credit loss distribution are expected loss and unexpected loss. Expected loss, based on loan exposure and historical default probabilities, is covered by the bank’s loan loss reserve. Unexpected loss is the actual loss over and above the expected loss. Economic Capital is set aside by banks which is above the loss reserve as required under the Basel requirement. Conceptually, Economic Capital is to protect from unexpected losses at a certain confidence level. VaR quantifies the extent of possible financial losses that could occur over a specified period. However, VaR does not possess the sub-additivity property. A superior measure is the conditional value at risk, a coherent risk measure, that incorporates the properties of monotonicity, translation invariance, sub-additivity and positive homogeneity.”
In addition, Prof Dr Lim also mentioned the Expected Shortfall as a measurement suited to capture extreme losses in a systemic market stress, though lacking in robustness when different probability distributions are used. Additionally, he demonstrated the Markowitz efficient frontier which can be used to allocate risk capital for speculative activity.
Before ending his webinar, Prof Dr Lim expressed his views on the risks and uncertainties faced by the world with the continuing Ukraine war, escalating energy prices, interest rates and inflation. He added that the consumer demand is reducing while the costs of production and borrowing for businesses are increasing. Additionally, he stated that climate risk and increasing number of natural disasters will add to the costs of rebuilding and maintenance for nations.
The insightful talk ended with Q&A and group photograph session.