Lecture 24. Example Correlation Coefficient =.4 Stocks  % of PortfolioAvg Return ABC Corp2860% 15% Big Corp42 40% 21% Standard Deviation = weighted.

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Presentation transcript:

Lecture 24

Example Correlation Coefficient =.4 Stocks  % of PortfolioAvg Return ABC Corp2860% 15% Big Corp42 40% 21% Standard Deviation = weighted avg = 33.6 Standard Deviation = Portfolio = 28.1 Additive Standard Deviation (common sense): = 28 (60%) + 42 (40%) = 33.6 WRONG Real Standard Deviation: = (28 2) (.6 2 ) + (42 2 )(.4 2 ) + 2(.4)(.6)(28)(42)(.4) = 28.1 CORRECT

Value at Risk = VaR Newer term Attempts to measure risk Risk defined as potential loss Limited use to risk managers Factors Asset value Daily Volatility Days Confidence interval

Standard Measurements 10 days 99% confidence interval VaR

Example You own a $10 mil portfolio of IBM stock. IBM has a daily volatility of 2%. Calculate the VaR over a 10 day time period at a 99% confidence level.

Example You also own $5 mil of AT&T, with a daily volatility of 1%. AT&T and IBM have a.7 correlation coefficient. What is the VaR of AT&T and the combined portfolio?