EFB344 - Risk Management - Recent Royal Commission - Management Assignment Help

Assignment Task:

EFB344: Risk Management Assignment Help

Overview
As a fund manager, you are aware that the recent Royal Commission into Misconduct in Banking, Superannuation and Financial Services Industry (Royal Commission) has raised many concerns about the performance of the financial shares in your clients’ portfolios. One client in particular has asked you to evaluate the risk on his portfolio of financials over the next year. You decide that it is best to undertake the risk assessment using the Value-at-Risk (VaR) approach and supplementing this analysis with a qualitative assessment of the outlook for their portfolio in light of the findings and recommendations of the Royal Commission.

Your task is to undertake a quantitative and qualitative assessment of the risk of the client’s portfolio for the next year. With that in mind, you decide to address the following questions:

(a) Calculate the VaR(99%) over the next 252 trading days as at immediately before the commencement of trading on March 1, 2019

You are aware of two methods which can be used to complete your VaR assessment:

(a) the normal distribution method using the exponentially weighted moving average (EWMA) model to estimate the variances and covariances of the assets in the portfolio; or

(b) historical simulation based on a rolling window. Both methods require choosing parameters to assign weight to past data: for the EWMA and the window length for the historical simulation. You decide to consider the following model specifications:

This leaves you with 4 possible models that could be used to provide the VaR measure asked for above. You must choose the most appropriate model, explain why your model is the most viable choice, and report the associated VaR (as a percentage). To inform your decision of which to use, you need to backtest the four models by calculating 1-day VaR(99%) and comparing the actual number of exceedances with the Basel Traffic Lights to determine if any models should be excluded on this basis. Consistent with the Basel framework, you should use a rolling 252 trading day window to compute the number of exceedances in the last year. In your analysis, you should also compare the actual number of exceedances with what was expected to distinguish between any models that pass the Basel test. Once you
have justified your choice of model, use it to estimate the VaR(99%) over the next year (252 trading days) as at immediately before the commencement of trading on March 1, 2019.

This part of the assignment is quite mechanical and can get quite tricky. However, once you’ve finally got the correct formulae, you can copy most of them across/down to save time (just be careful when doing so). Here is a list of the tasks you will need to perform (in order):

1. Calculate the returns on the individual stocks as well as the portfolio;

2. Find the variances of the returns for each stock, as well as the covariances of the returns between the assets in the portfolio in accordance with the EWMA models
specified. (Hint: This is perhaps the hardest and most time-consuming part of the calculations, so particular care should be taken here. You can have a look at how
EWMA is done in the “VaR – ASX200” and “Portfolio Variance” spreadsheets, which are available in Assignment Resources, and think about how you might adapt them
for the assignment. Since variance and covariance are time-varying, you should have a unique estimate of them for each trading day. In addition, since there are four
stocks in the portfolio, there are 16 variance/covariance terms to consider (10 unique terms, given the variance/covariance matrix is symmetrical). Since there are two
EWMA models and EWMA2 is only asking you to change the lambda for covariance, you should have at least 16 columns of variance/covariance estimates);

3. Using your answers in (2), calculate the variance of the portfolio for each day;

4. Calculate the Portfolio VaR according to each model for each day;

5. Calculate the actual number of exceedances, and compare them to the Basel Traffic Lights framework;

6. Compare the actual number of exceedances with what was expected;

7. Once you have found the preferred model, justify why you chose it and use it to report the VaR(99%) for the next 252 trading days.

(b) Do you believe your VaR estimate accurately represents the downside risk (risk of loss) of the portfolio? 

This is the subjective part of the task, where you are required to justify whether your estimate of VaR represents the true downside risk of the portfolio. To avoid confusion and to streamline your thought processes, you should have regard to two (2) potential risk factors such as ‘black swans’ or even reasonably foreseeable events arising only as a result of the Royal Commission. This will require you to undertake some independent research on the individual stocks, as well as some of the potential regulations/interventions that might/will affect those stocks. You should also familiarise yourself with some of the relevant recommendations made in the final report, which you can find here. You can also read some news articles, press releases and blogs to gain an understanding of the issues.

You should note that it is not enough to simply state the issues that may not be captured in your VaR model. You need to provide strong justification as to why you feel the way you do about the VaR estimate based on logical arguments and appropriate references. You should also attempt to highlight the effects that your qualitative findings have on your quantitative risk assessment. However, you do not have to physically quantify it. As a rough guide, this part should be approximately 500 words in length, give or take 10%.

Do not simply state the limitations of VaR models generally, as you will not be awarded any marks for this. Instead, you are rewarded for showing an understanding of current affairs and its application to the portfolio, being able to identify potential qualitative factors that might occur in the future (futuristic thinking), assessing its impact on your analysis, and providing strong justification for your analysis.

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