value at risk studies of industrial security portfolio by naman swaroop

Value at Risk

A PRESENTATIONON

VALUE AT RISK (VaR) STUDIES OF INDUSTRIAL SECURITIES PORTFOLIO

A METHODOLOGY FOR OPTIMIZING PORTFOLIO RISK USING CRYSTAL BALL

PRESENTED BYNAMAN SWAROOP

057515Mob:9358423378

Value at Risk

INTRODUCTION

For Investors, risk is about the odds of losing money.

What is my worst case scenario?How much could I lose in a really bad month?

Value at Risk

INTRODUCTION

“VAR summarizes the worst case loss over a target horizon with a given level of confidence.”

- Philippe Jorion

“Value at risk measures the worst case expected loss that an institution can suffer over a given time interval under normal market conditions at a given confidence level. It assesses this risk by using statistical and simulation models designed to capture the volatility of assets in a portfolio.”

-Cormac Butler

Value at Risk

INTRODUCTION

A portfolio is a bundle or combination of individual assets or securities.

VaR of a portfolio is simply

σ X z σ:standard deviation of portfolio z: z score value at a given confidence. eg:2.33 @ 99%

Value at Risk

VaR CALCULATION METHODS

Three methods:

1. HISTORICAL METHOD2. VARIANCE-COVARIANCE METHOD3. MONTE-CARLO SIMULATION

Value at Risk

MONTE CARLO METHOD(MCS) Historical/Implied

Data

Model parameters

FUTURE PRICES

Full Valuation

Securities Model

Portfolio Positions

Distribution Of values

STOCHASTIC

MODEL

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CRYSTAL BALL (CB)& MCS

CB WORKING MODEL

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PROBLEM IDENTIFICATION

How investors can lower the risk in their equity investment portfolio by sensible diversification ?

Value at Risk

OBJECTIVES

• To calculate the Value at Risk of the industrial securities portfolio, so that, the investor can invest in modified Sensex portfolio by choosing similar alternative securities within ‘A’ group securities in terms of volatility with his own level of risk taking ability.

• To understand the awareness of institutional investor and the technique used by those to manage risk adjusted return.

Value at Risk

NEED OF THE STUDY

An investor invests on the basis of his risk taking ability. This study is to develop a methodology to measure or to calculate the possible loss in worst case. If the investor is ready to take that much of the risk, then only he will invest in that portfolio.

Value at Risk

RESEARCH METHODOLOGY• NATURE OF THE STUDY: Analytical Study• SAMPLING TECHNIQUE: Judgmental Sampling (Sensex)

• SAMPLE• Primary Data: A web based questionnaire was developed for

professionals working in the field of Risk Management.• Sample Size : 3

• Secondary Data: The secondary data (share prices) is collected from www.bseindia.com

• SOFTWARE USED FOR STATISTICAL CALCULATIONMS Excel 2003Crystal Ball 5.1 Student Edition

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ANALYSIS

ASSUMPTIONS– Dividend is not taken into consideration.– The Scrip’s rate of return follows a normal

distribution.– The holding period for VaR calculation is one

day.

Value at Risk

ANALYSIS

• STEP ONE– Data Adjustment

– Capital Gain(P1-P0) / P0

– Average Rate of Return– Standard Deviation (Volatility)– Correlation Matrix

BAJAJAUTO(dummy data)

0

500

1000

1500

2000

2500

3000

3500

1 176 351 526 701 876 1051 1226 1401 1576 1751

Observations

pri

ce

BAJAJAUTO

0

500

1000

1500

2000

2500

3000

3500

1 176 351 526 701 876 1051 1226 1401 1576 1751

Observations

Pri

ce

ADJUSTMENT

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ANALYSIS

• STEP TWO– Sorting– Formation of Portfolio

Portfolio 1 Portfolio 2 Portfolio 3 Small Standard Deviation Medium Standard Deviation High Standard Deviation GLAXO RANBAXY IPCL BAJAJAUTO GRASIM INFOSYSTCH ABB DRREDDY BPCL HINDALC0 SUNPHARMA SatyamAdj SBIN ONGC SAIL RELIANCE ORIENTBANK WIPRO HDFCBANK DABUR HCLTECH ACC GAIL VSNL CIPLA BHEL ZEETELE SIEMENS MTNL ICICIBANK

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ANALYSIS• STEP 3

– Portfolio Values are inserted– Crystal Ball is invoked

• STEP 4– Assumptions, Decision Variables & Forecast Cells

are defined.– MODELLING EQUATION

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ANALYSIS

• STEP 5– SIMULATION– The Crystal Ball generates the descriptive

statistics.

Demonstration

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FINDINGS

QUESTIONNAIRE

NAME DESIGNATION ORGANISATION SWAMI DAYAL FINANCIAL ANALYST /

CREDIT OFFICER DENA BANK

NISARG A. DESAI MARKET RISK ANALYST

ICICI BANK LIMITED

SACHIN BANSAL MANAGER - RISK ANALYTICS

CREDIT SUISSE

1

2

3

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FINDINGS

QUESTIONNAIRE: Financial Institutional Investors• Measuring risk is one of the crucial activities carried out by

these financial institutions.• These institutions have group of experts for the purpose of

calculating VaR.• As per the response from the designed questionnaire we

have seen the that , Value at Risk is being used by the financial institutions. It is very specialized field of activity, utilized by experts.

• For the purpose of calculation of VaR, they are using almost all possible method of calculations.

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FINDINGS

• PORTFOLIO ANALYSISVaR is calculated at

99% confidence95% confidence

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FINDINGS:VaR @ 99 %

PORTFOLIO 1

VALUE @

RISK

Value at Risk

FINDINGS:VaR @ 99 %

PORTFOLIO 2

VALUE @

RISK

Value at Risk

FINDINGS:VaR @ 99 %

PORTFOLIO 3

VALUE @

RISK

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FINDINGS:VaR @ 95 %

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FINDINGS: MODIFIED PORTFOLIO

We Repalced ICICI with PNB in portfolio 3 and run the simulation.

VALUE @ RISK

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FINDINGS: TABLE OF RESULTS

PORTFOLIO STANDARD DEVIATION

MINIMUM (Rs)

MAXIMUM (Rs)

MEAN (Rs)

PORTFOLIO 1 2,959.92 -9,032.22 10,638.20 204.54 PORTFOLIO 2 3,042.05 -8,474.52 10,712.97 221.81 PORTFOLIO 3 5,676.53 -17,278.36 20,330.57 393.11 PORTFOLIO 3* 4,867.49 -14,254.34 17,327.22 685.78

Modified Portfolio

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RECOMMENDATIONS

While maintaining the return it is possible to reduce the VaR in a portfolio by substituting with a less volatile security from a group instead of most volatile sensex security.

Such improvement in the risk adjusted return on capital (RAROC) can be achieved in each of the 3 above mentioned portfolios.

It is for each institutional investor to restructure his equities portfolio in accordance with his objectives using the tools and techniques that have been demonstrated in this project work.

Value at Risk

CONCLUSION

The methodology used to optimize the portfolio risk by measuring value at risk of the portfolio is very useful in real life situation also, as it is based on Monte Carlo Simulation. An investor can easily identify his preferred portfolio by knowing the worst case loss. The calculations are based on real life data; hence it presents a true picture of calculations and behavior of portfolio value.

Value at Risk

LIMITATIONS

Crystal Ball

Time and hardware restrictions made it extremely difficult to examine a large number of equity substitutions for observing there effect on risk and return .

Value at Risk

LIMITATIONS

Questionnaire

Number of responses to the questionnaire was very small owing to the necessity of inviting responses from experts in this area of specialization. Moreover this time of the year the expert are tied-up with preparation of annual accounts for the year ended 31st march and so getting responses from them was extremely difficult.

Value at Risk