The Handbook of News Analytics in Finance

17.2 THE PROBLEM OF INCOMPLETE INFORMATION IN MARKET RISK ASSESSMENT

The sole purpose of financial risk management is to identify or anticipate potential risks before they occur, thereby possibly preventing companies from potential disasters or minimizing their effects.

Market risk assessment constitutes a significant part of the estimation of financial risk. It is calculated using risk measures, expressed in risk metrics, and has traditionally been estimated using historical data. This has the disadvantage that it provides a retrospective indication of risk that may not be a proper indication of current and future risk under unstable market conditions. Currently, the popular measures used for estimating market risk are Value at Risk (VaR) and Expected Shortfall (ES) metrics. It is vital for companies to know about risks at the moment that decisions are made, and VaR or ES enable this by incorporating future prospects into their risk calculation by using probability distributions. However, classical VaR calculation assumes that only the risk of single assets and their correlation (or dependence) matters. It does not take sudden market changes into account. As a consequence, this makes VaR inflexible and unresponsive with regard to abnormal market conditions, such as with the instability caused by high-impact news events or an economic crisis.