Topics in financial market risk modelling

Abstract

The growth of the financial risk management industry has been motivated by the increased volatility of financial markets combined with the rapid innovation of derivatives. Since the 1970s, several financial crises have occurred globally with devastating consequences for financial and non-financial institutions and for the real economy. The most recent US subprime crisis led to enormous losses for financial and non-financial institutions and to a recession in many countries including the US and UK. A common lesson from these crises is that advanced financial risk management systems are required. Financial risk management is a continuous process of identifying, modeling, forecasting and monitoring risk exposures arising from financial investments. The Value at Risk (VaR) methodology has served as one of the most important tools used in this process. This quantitative tool, which was first invented by JPMorgan in its Risk-Metrics system in 1995, has undergone a considerable revolution and development during the last 15 years. It has now become one of the most prominent tools employed by financial institutions, regulators, asset managers and nonfinancial corporations for risk measurement. My PhD research undertakes a comprehensive and practical study of market risk modeling in modern finance using the VaR methodology. Two newly developed risk models are proposed in this research, which are derived by integrating volatility modeling and the quantile regression technique. Compared to the existing risk models, these two new models place more emphasis on dynamic risk adjustment. The empirical results on both real and simulated data shows that under certain circumstances, the risk prediction generated from these models is more accurate and efficient in capturing time varying risk evolution than traditional risk measures. Academically, the aim of this research is to make some improvements and extensions of the existing market risk modeling techniques. In practice, the purpose of this research is to support risk managers developing a dynamic market risk measurement system, which will function well for different market states and asset categories. The system can be used by financial institutions and non-financial institutions for either passive risk measurement or active risk control.