Title: Measuring and modelling risk

Authors: David E. Allen

Addresses: School of Accounting, Finance and Economics, Edith Cowan University, Joondalup Campus, 270 Joondalup Drive, Joondalup, WA, Australia

Abstract: This paper will examine some commonly adopted approaches to the measurement of risk in finance and the various shortcomings implicit in the underpinnings of these approaches: early views on the nature of risk and uncertainty (Hume, Bernoulli, Knight, Keynes and Ramsey); the adoption of a mean variance decision choice criteria as a central foundation in financial economics and its accompanying limitations; the various approaches in financial econometrics to modelling volatility (ARCH, GARCH, stochastic volatility, realised volatility and attempts to capture |tail risk|); the measurement of risk implicit in applications of option pricing models and implied volatility (in particular the VIX index); the Basel Agreements and convention of modelling risk in a value at risk (VaR) framework; and the attractions of conditional value at risk (CVaR) as an alternative metric. I shall conclude with a consideration of the shortcomings of these various approaches when faced with a system wide shock as recently experienced in the global financial crisis.

Keywords: risk measurement; mean-variance risk analysis; financial econometrics; conditional VaR; CVaR; risk modelling; financial risk; value at risk; financial crisis; option pricing models; volatility.

DOI: 10.1504/GBER.2009.031169

Global Business and Economics Review, 2009 Vol.11 No.3/4, pp.199 - 224

Published online: 24 Jan 2010 *

Full-text access for editors Full-text access for subscribers Purchase this article Comment on this article