1.3 Quantitative Measurement and a Consistent Framework

The measurement of risk, the language of risk, seemingly even the definition of risk itself—all these can vary dramatically across assets and across the levels of a firm. Traders may talk about DV01 (dollar value of an 01) or adjusted duration for a bond, beta for an equity security, the notional amount of foreign currency for a foreign exchange (FX) position, or the Pandora's box of delta, gamma, theta, and vega for an option. A risk manager assessing the overall risk of a firm might discuss the VaR, or expected shortfall, or lower semivariance.

This plethora of terms is often confusing and seems to suggest substantially different views of risk. (I do not expect that the nonspecialist reader will know what all these terms mean at this point. They will be defined as needed.) Nonetheless, these terms all tackle the same question in one way or another: What is the variability of profits and losses (P&L)? Viewing everything through the lens of P&L variability provides a unifying framework across asset classes and across levels of the firm, from an individual equity trader up through the board.

The underlying foundations can and should be consistent. Measuring and reporting risk in a consistent manner throughout the firm provides substantial benefits. Although reporting needs to be tailored appropriately, it is important that the foundations—the way risk is calculated—be consistent from the granular level up to the aggregate level. ...

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