Few answers: 1. relatively easy to calculate (deterministically or stochastically), concept easy to communicate, can combine VaRs across multiple risks, widely used and understood across banking/insurance sectors 2. deliberately increasing risk in expectation of higher reward v taking positions that net reduce risk (in return for lower reward or loss of upside) You're welcome
Thanks for the reply. 1. please elaborate on few points of differnce between speculation and hedging. I really could not understand much here? 2. what is the meaning of derivative outlay in reference to paragraph extract from page 17 of ch-22 below: 'Such overlays can therefore be used: to obtain immediate re-allocation of funds between asset categories (which would then be unwound as the cash market deals were made) as a means of altering the portfolio structure on a medium-term basis (ie the underlying cash market deals will not take place and the swap will remain in place until the next restructuring decision is made) to change the nature (ie fixed or floating) and/or duration of a fixed interest portfolio to obtain international diversification' 3.what is the difference between 'representative heuristics' and 'availability' under section 4.6 of ch-6(estimating probabilities)? These appear to be almost same. Thanks
Speculation is taking a risk to get a higher return, usually in a short term manner. The exposure may not be exposure to an asset that the institution would normally consider suitable for its liabilities. Hedging involves taking an opposite exposure that offsets something else in the portfolio, thus "hedging" the risk. The sentence you refer to in (2) means that the institution would change the exposure to asset categories by using derivatives. The actual assets (cash market assets) would then be switched more slowly into the correct areas. Each time the cash market assets are switched, a part of the derivative position would be unwound. Representative Heuristics is where a person thinks that the probability of something is higher if you describe it in more detail. So an economic scenario would seem likely if an economist gave a detailed explanation of how and why it might come about. Availability means that probabilities of things that are easily imagined seem higher. Thus more commonplace events which are easier to picture, seem more likely.
thanks for the reply. Another quick question, can we use speculate without using derivatives? if yes, give me an example?
Yes. You could invest directly in a risky asset (eg buy shares in company that you hope will increase in value). Have you ever bought a lottery ticket or placed a bet at a bookies? Gambling is also a form of speculation.
What is the difference between Liability hedging and Liability driven investment?... seems to be a very thin line to me.
