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Subject 4. Applications of Risk Measures PDF Download
Three factors influence the types of risk measures used by different market participants.

  • The degree of leverage
  • The mix of risk factors to which the business is exposed
  • Accounting or regulatory requirements

Banks use risk tools to assess the extent of any liquidity and asset/liability mismatch, the probability of losses in their investment portfolios, their overall leverage ratio, interest rate sensitivities, and the risk to economic capital.

Asset managers' use of risk tools focuses primarily on volatility, probability of loss, and the probability of underperforming a benchmark.

  • Ex ante tracking error uses current portfolio holdings exposed to the variability of historical markets, whereas ex post tracking error measures the variability of historical portfolio holdings in historical markets.

Pension funds use risk measures to evaluate asset/liability mismatch and surplus at risk.

Property and casualty insurers use sensitivity and exposure measures to ensure exposures remain within defined asset allocation ranges, economic capital and VaR measures to estimate impairment in the event of a catastrophic loss, and scenario analysis to stress the market risks and insurance risks simultaneously.

Life insurers use risk measures to assess the exposures of the investment portfolio and the annuity liability, the extent of any asset/liability mismatch, and the potential stress losses based on the differences between the assets in which they have invested and the liabilities resulting from the insurance contracts they have written.

Learning Outcome Statements

describe risk measures used by banks, asset managers, pension funds, and insurers;

CFA® 2023 Level II Curriculum, Volume 5, Module 42

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