Basically, risk management deals with the problem of protecting a portfolio or trading book against unexpected changes of market prices or other parameters. It therefore expresses the desire of a portfolio manager or trader to guarantee a minimum holding period return or to create a portfolio which helps him to fullfil specific liabilities over time. Risk management may help to avoid extreme events, to reduce the tracking error or even the trading costs. However, there are different possibilities for setting up a risk management or hedging process. The method which should be applied may well depend on the time horizon of the risk manager. If he is interested in controlling short-term risk, or if he would like to hedge against small movements in market prices, he may decide for a sensitivity-based risk management. This method is described in Section 7.1. If he has a longer time horizon and wants to be safe against large market movements he may decide for a downside risk management, which is discussed in Section 7.2.
KeywordsRisk Management Return Distribution Portfolio Manager Goal Function Downside Risk
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