Risk providers respond (part 5): When measuring extreme losses, which risk measures work?

Some highlights from our episode:

Oleg Ruban, Senior Associate of Applied Research and Patrick D'Orey, Vice President, Head of Europe Equity Analytics of MSCI Barra

...An important thing to highlight here is differences between measures and the distribution, so it’s not that the measures that have been used in the past are necessarily inaccurate. So things like obvious risk and conditional value at risk may definitely have their place in portfolio construction and risk management.

Sebastian Ceria, CEO and Olivier D'Assier, Managing Director for the EU and Asian Markets of Axioma

When the crisis happened, we were already working with an approach to deal with measures, risk measures that take into consideration the downside risk more than just variance [or tracking error] that we use for our equity portfolios. Our experience has been that after the crisis, our clients and prospects have become a lot less focused on that, and they believe that the world is moving towards a more normal environment where looking at extreme risk for straight equities is not as important. 

Dan diBartolomeo, President and founder of Northfield Information Services

No set of static measures is going to be sufficient. The issue isn’t about what measure you use. I think that’s kind of silly. What matters is what’s the probability distribution under which you assume those measures operate.

Laurence Wormald, Head of Research, Sungard APT

So first thing to say, I think you need a 360 degree view of your risk, and to get that you need to look at all the risk measures available, so conventional beta, conventional durations and volatilities or tracking errors depending on whether it’s an institution or hedge fund, conditional value at risk is probably the best measure for the downside.

Jason MacQueen, founder, R-Squared

Our own view at R-Squared is that the solution to this problem is to have a model for normal times and a model for turbulent times....So I think in the future what we’ll have is risk models that kind of capture the behavior of normal times, which people can use for all the normal risk monitoring, risk measurement and optimization sorts of things, and then we’ll probably have models which are deliberately designed to tell you what your exposures would be to extreme events of one sort or another.