Risk Measures in Asset Management
This chapter presents the mathematical prerequisites for measuring risk and return in asset management. It provides basic information together with many exercises and case studies and describes traditional and non-traditional measures: volatility and Shar
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Risk Measures in Asset Management
1.1
Introduction
Everyone has heard of stock market crashes in the time between 2008 and now, whether he or she followed the events on the financial markets or not. The subprime crisis, which unfolded in 2008, has affected every person in almost every country in the world. When we try to explore what happened, as we intend to do in this book, we are immediately drawn to key questions of today’s discussions in finance and economics: Why does traditional finance theory fail to explain these crises and why seems behavioral finance, the psychology of investing, better suited to provide an explanatory model? The first of the two focal questions of this book is, therefore: Why do crashes happen when in theory they should not? The second question is: How have investors reacted to the recent crisis in terms of their risk measurement and management and what are the implications for the chosen investment strategies? Centered around these two key questions, this book provides a thorough introduction to applied asset and risk measurement in today’s markets which are more and more driven by behavioral finance as could be observed in 2008 (a stock market crash) and 2009 (a stock market rally). The six chapters are designed to answer the two questions above by offering a structured introduction to modern portfolio management, behavioral finance and abnormal market behavior. Thereby, this book is ideally suited for bachelor and master students in the field of modern portfolio management as well as for young professionals in the asset and risk management industry. Chapter 1 presents the mathematical prerequisites to understand the mathematical part of what follows thereafter. While the mathematical description is not the focus of this book, formulas cannot be completely avoided as finance, and here in particular asset management, is about performance and risk. Therefore, Chap. 1 presents the measurement of both with many applications. Chapter 2 then explains
© Springer-Verlag Berlin Heidelberg 2015 M. Schulmerich et al., Applied Asset and Risk Management, Management for Professionals, DOI 10.1007/978-3-642-55444-5__1
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the theory of asset management, also known as modern portfolio theory (MPT) as introduced in the 1950s by Harry Markowitz. The focus is placed on the capital asset pricing model (CAPM) and its extension, the Fama-French three-factor model. In particular, the key historical tests undertaken in the past 50 years will be presented to see how the theory holds against reality. The remaining four chapters of this book deal with the reality of investor behavior and stock markets. Chapter 3 provides an overview of stock market anomalies which should not exist according to MPT. However, they do exist and have been extensively researched since the early 1980s. Thereafter, Chap. 4 presents a historical survey of the most significant market crashes. Chapter 5 then returns to the question how crashes can happen. To answer it, the psychology of invest
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