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2.2 Introducing market risk

Typically, market risk can be divided into several sub types. Most of the splitting is obvious, but some of the more exotic risk types remain very broad. The ideal breakdown depends heavily on the specific portfolio whose market risk shall be quantified. A basic approach fitting most portfolios of private investors, not too broad, not too granular, is chosen in OCTARISK. The following types of risk are defined:

The OCTARISK projects focuses on these risk types. For each risk type, appropriate risk factors can be chosen. One risk factor is a typical representative of a particular risk type. Most often, several risk factors are needed to describe the granular behavior of a market risk type, e.g. it is necessary to describe the specific characteristics of countries, regions or currencies. For example, two risk factors can be used to describe the international equity market movements: Developed markets and emerging market. If desired, developed market can be further split into North America, Europe and Asia to describe risk diversification effects between these broad regions. After the selection of risk factors, stochastic models are chosen, calibrated and subsequently used for scenario generation.


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