Portfolio Risk Analysis

By Gregory Connor; Lisa Goldberg et al. | Go to book overview

8
Integrated Risk Models

Previous chapters have discussed risk models for individual asset classes such as stocks, bonds, and foreign exchange. This chapter discusses the integration of asset-class risk models into models of aggregate portfolio risk, reaching across asset types and across national borders. The choice of architecture for a multicountry and/or multitype risk model depends crucially on the empirical structure of returns. If the common factors across asset types and countries are nearly the same, then the best architecture is a fully integrated approach. If, on the other hand, the markets are subject to very different factor risks, then a more segmented approach is preferable.

Section 8.1 defines international capital market integration and surveys the empirical evidence on the level and trends in international integration. Section 8.2 presents empirical evidence on integration across asset types. Section 8.3 discusses segmented risk models, in which the risk manager first analyzes the risk of the asset-class allocation and then the active risk of the subportfolio within each asset class. Section 8.4 discusses integrated risk models in which asset-class risk and security-selection risk are analyzed simultaneously.


8.1 Global and Regional Integration Trends

8.1.1 Definitions of International Capital Market Integration

There are at least three different definitions of international capital market integration. The most fundamental definition relates it to the presence of a common asset pricing model applying across national boundaries. We will call this pricing integration. For simplicity, consider the case of the capital asset pricing model:

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Portfolio Risk Analysis
Table of contents

Table of contents

  • Title Page iii
  • Contents vii
  • Acknowledgments xi
  • Introduction xiii
  • Key Notation xix
  • 1: Measures of Risk and Return 1
  • 2: Unstructured Covariance Matrices 36
  • 3: Industry and Country Risk 61
  • 4: Statistical Factor Analysis 79
  • 5: The Macroeconomy and Portfolio Risk 101
  • 6: Security Characteristics and Pervasive Risk Factors 117
  • 7: Measuring and Hedging Foreign Exchange Risk 134
  • 8: Integrated Risk Models 155
  • 9: Dynamic Volatilities and Correlations 167
  • 10: Portfolio Return Distributions 191
  • 11: Credit Risk 212
  • 12: Transaction Costs and Liquidity Risk 241
  • 13: Alternative Asset Classes 271
  • 14: Performance Measurement 299
  • 15: Conclusion 319
  • References 323
  • Index 345
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