Block M · Risk management & risk analysis

‹ Financial markets handbook: overview

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Risk management does not mean avoiding risks but choosing, measuring, limiting and surviving them deliberately; the order is the program: identify, measure, steer, report.

151 · Risk types at a glance (market, credit, liquidity, operational risk)

Definition: Market risk (prices), credit risk (default), liquidity risk (tradability/refinancing), operational risk (processes, systems, people); plus concentration and model risk as cross-cutting themes.

Use: A completeness checklist for every risk inventory.

Interpretation: The crisis rarely comes from the measured category; operational and liquidity risks are chronically underestimated.

Typical mistake: Narrowing risk management to market risk.

152 · Market risk & factor models

Definition: Loss potential from price moves; factor models decompose it into systematic drivers (rates, spread, equity market, style, currency) plus security-specific components.

Use: Making hidden bets visible; assigning risk budgets per factor.

Interpretation: Two "different" portfolios can have identical factor profiles.

Typical mistake: Looking only at position weights instead of factor exposures.

153 · Credit risk parameters (PD, LGD, EAD, expected loss)

Definition: PD = probability of default, LGD = loss given default, EAD = exposure at default; expected loss = PD x LGD x EAD.

Use: Assessing credit risks beyond the rating; provisioning/pricing logic.

Interpretation: Same rating, different LGD (collateral, rank!) mean different risk.

Typical mistake: Looking only at PD; the rank decides the loss size (see the liability cascade in ch. 5-B).

154 · Liquidity risk (market vs. funding liquidity)

Definition: Market liquidity (a position not sellable without a price discount) vs. funding liquidity (payment obligations cannot be met).

Use: Liquidity classes per position; stress planning (commitments, margin calls, withdrawals).

Interpretation: Liquidity disappears in correlation with falling prices; planned sale sources dry up simultaneously.

Typical mistake: Not mirroring liquidity needs (PE capital calls, taxes) against liquidity sources under stress.

155 · Counterparty risk (counterparty, issuer risk in certificates)

Definition: Default of the counterparty of OTC transactions, deposits or certificates before fulfilment.

Use: Limits per counterparty; collateralization, clearing, diversification of banks.

Interpretation: Hidden counterparty risk sits inside products (certificates, swap ETFs, TRS).

Typical mistake: Overlooking the issuer risk of certificates held as a "bond substitute".

156 · Concentration risks

Definition: Dominance of single securities, issuers, sectors, countries or factors in overall risk.

Use: Limits (e.g. max 5% per issuer); family wealth: think business stake + portfolio together!

Interpretation: Risk contribution counts, not capital weight; 10% in a high-vol stock can represent 30% of the risk.

Typical mistake: Not including the family business outside the portfolios in the concentration calculation.

157 · Currency risk in the portfolio

Definition: Value change from FX moves of all non-EUR positions (also indirectly: a EUR ETF on US equities carries USD risk).

Use: Measuring the exposure, setting the hedge ratio (see 77).

Interpretation: The fund currency is NOT the currency risk; what counts is the currency of the underlyings.

Typical mistake: Confusing a EUR share class with currency-hedged ("hedged" must say so explicitly).

158 · Stress tests & scenario analyses (historical, hypothetical, forward-looking)

Definition: Revaluing the portfolio under defined shocks; historical (2008, 2020, 2022), hypothetical (+200bp, -30% equities) or forward-looking (rate paths).

Use: Testing loss tolerance BEFORE it happens; communication with family/committees ("what if").

Interpretation: Scenarios complement VaR exactly where it is silent (extreme events, correlation breaks).

Typical mistake: Running only historical scenarios; the next crisis rhymes, it does not repeat.

159 · Monte Carlo simulation

Definition: Thousands of random paths from assumptions on return, vol and correlation; yields result distributions instead of point forecasts.

Use: Withdrawal plans, goal achievement probabilities, foundation payout ratios.

Interpretation: The result is only as good as the assumptions; above all the correlation assumptions.

Typical mistake: The normal distribution assumption: extreme risks are systematically underestimated.

160 · Tail risk, skewness & kurtosis (why volatility is not enough)

Definition: Properties of the distribution tails; skewness (asymmetry) and kurtosis (fat tails) reveal what volatility conceals.

Use: Correctly classifying premium-collecting strategies (option selling, carry, cat bonds): steady gains, rare large losses.

Interpretation: Negative skewness + high kurtosis = "up the stairs, down the elevator".

Typical mistake: Comparing Sharpe ratios across strategies with different skewness.

161 · Risk budgeting & risk parity

Definition: Allocation by risk contributions instead of capital weights; risk parity = equal risk contribution per building block (often with leverage on bonds).

Use: Deliberate distribution of risk; an alternative to the 60/40 capital logic.

Interpretation: 60/40 in capital is ~90/10 in risk; equities dominate almost every mixed portfolio.

Typical mistake: Overlooking the risk parity leverage risk (the 2022 rate rise!).

162 · Drawdown management & stop-loss logic

Definition: Rules for loss limitation: loss thresholds with allocation reduction, trend filters, re-entry rules.

Use: Mandates with hard loss limits; protecting risk capacity.

Interpretation: Every loss limitation costs return (whipsaw); what matters is the re-entry rule, not the exit.

Typical mistake: Regulating the exit and leaving the re-entry to gut feeling; that turns protection into permanent cash.

163 · Hedging with derivatives (application perspective)

Definition: Bringing Block E together into the risk toolbox: index puts (crash), futures (lowering the allocation fast), FX forwards (currency), swaps/swaptions (rates), CDS (credit).

Use: Choosing the instrument by risk type, horizon and cost budget.

Interpretation: Perfect hedges are expensive; usually hedging the unbearable part (tail) suffices, not every fluctuation.

Typical mistake: Hedging after the crash (vol expensive) and unwinding before the next rise.

164 · Risk tools: Bloomberg PORT/MARS, Aladdin, BlackRock Portfolio 360

Definition: PORT (the Terminal standard: factor risk, VaR, scenarios), MARS (multi-asset/derivatives, additional license), Aladdin (the institutional full platform), BlackRock Portfolio 360 (free Aladdin-based analysis for professionals, see chat note 17.08.2026).

Use: The tool by complexity and budget; 360 as a free second opinion, PORT as the daily workhorse.

Interpretation: Models of the same family share blind spots; a second model with a different methodology is valuable.

Typical mistake: Adopting model results without a plausibility check (one's own back-of-the-envelope duration/beta calculation).

165 · Risk reporting & limit systems

Definition: Regular reports (exposure, risk, performance, limit utilization) plus an escalation process on a breach.

Use: The governance close of the loop; in a family office the basis of the family/advisory board report.

Interpretation: Good reports are short, comparable over time and show changes, not just holdings.

Typical mistake: Documenting limit breaches but having no defined escalation path.

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