Extreme Events in Finance

Chapter 10Measures of Financial Risk

S.Y. Novak

School of Science and Technology, Middlesex University, London, UK

AMS 2000 Subject Classification: primary 60G70; secondary 60G55, 60E15. JEL Classification: C53, G17.

10.1 Introduction

Accurate evaluation of risk is fundamental to the financial well-being of financial institutions as well as individual investors. However, the issue is demanding. It involves sophisticated statistical analysis of market data.

The traditional approach to risk measurement is capable of forecasting the magnitude of a possible sharp market movement (see, e.g., Novak and Beirlant, 2006). However, the estimates appear static: they barely change with the inflow of new information, and may be unsuitable for active portfolio management. The “Technical Analysis” (TA) approach offers a truly dynamic risk measure (cf. Novak, 2011, Chapter 10). However, the lack of statistical scrutiny affects its credibility. The main obstacle that prevents building a body of empirical evidence either in favor or against the use of is the computational difficulty caused by the fact that price charts appear objects of fractal geometry.

Section 10.2 briefly overviews the popular measures of risk, including value at risk (VaR) and a related measure called conditional VaR (CVaR) ...