An Introduction to Analysis of Financial Data with R

One of the lessons we learned from repeated financial crises is that risk is real and should be an integral part of any financial decision. Assessing financial risk thus becomes important in asset pricing and allocation. In this chapter, we introduce some risk measures for quantifying financial risk, discuss statistical methods for calculating financial risk and the theory behind them, and demonstrate risk assessment via real examples. Similar to other topics discussed in the previous chapters, our goal here is to provide readers with basic knowledge about financial risk and risk management. We use real examples in the demonstration, and all computations are carried out step-by-step with R.

Following the framework of Basel Accords, financial risk can be classified into three categories. They are market risk, credit risk, and operational risk. If necessary, one can treat liquidity (or refinancing) risk as an additional category. Market risk is concerned with loss arising from changes in stock prices, interest rates, foreign exchange rates, and commodity prices. It includes equity risk, interest rate risk, currency risk, commodity risk, and volatility risk. Because equity prices and interest rates are widely available and of high quality, market risk is the most well-studied and understood financial risk. It is also the main focus of this chapter.

Credit risk is also known as default ...