# Risk Mgmt and Capital Requirements in Banking

Lecture 3.1 Vorlesung 19.02.2014

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Flashcards 31 Deutsch Finance University 20.02.2014 / 24.04.2014 Not defined https://card2brain.ch/box/risk_mgmt_and_capital_requirements_in_banking

According to Donald Rumsfeld there are risks that are known knows, known unknown and unknown unknowns. What is the meaning of those phrases?

known knowns = risk we know and can measurable

known unknowns = risk we know, but not measurable

unknown unknowns = risk we don't know and therefore not measurable

A farmer is sowing soybeans today and harvest in future. Which two factors have impact on the value of the harvest? And how does the formula looks like?

Factors that have an impact on the value of the harvest: Change in Price and Change in Quantity

According to Neumann - Morgenstern

1. Which shape has an utility function for risk aversion?

2. Which condition has to be exist regarding utility of expected value and expected utility?

1. concave

2. U(E((x)) > E(U(x))

According to Neumann - Morgenstern

1. Which shape has an utility function for risk neutrality?

2. Which condition has to be exist regarding utility of expected value and expected utility?

1. linear

2. E(U(x)) ? U(E(x))

Which are the 4 Axioms of Expected Utility according Neumann - Morgenstern?

1. Completeness

2. Transitivity

3. Continuity

4. Substitution

What does the Allais Paradox describes?

Decision1: Choose between (A) an 80% chance of $4000; (B)$3000 for sure.

Decision2: Choose between (C) a 20% chance of $4000; (D) a 25% chance of$3000.

Which axiom is violated?

unsufficient description of human behavior towards risk.

B over A; C over D --> result violates the substitution axiom (= common ration effect)

From decision1 to decision2 one goes from a certain to a uncertain situation. In this case certainty creates additional value.

What is the statement of the Asian Disease Example?

People act risk-aversely when dealing with gains/profits.

People are getting riskier by dealing with losses.

Market Risk

1. Potential of loss because of unexpected changes in market prices

2. generally symmetrical distribution

Example: Depreciation of USD leads to decline in the CHG value of USD assets.