‘The Prayer’ Ten-Step Checklist for Advanced Risk and Portfolio Management

Abstract

We present “The Prayer”, a recipe of ten sequential steps for all portfolio managers, risk managers, algorithmic traders across all asset classes and all investment horizons, to model and manage the P&L distribution of their positions.

For each of the ten steps of the Prayer, we introduce all the key concepts with precise notation; we illustrate the key concepts by means of a simple case study that can be handled with analytical formulas; we point the readers toward multiple advanced approaches to address the non-trivial practical problems of real-life risk modeling; and we highlight a non-exhaustive list of common pitfalls.

Keywords: Quest for Invariance, Conservation Law of Money, Estimation, Projection, Pricing, Aggregation, Attribution, Evaluation, Optimization, Invariants, Risk Drivers, Random Walk, Levy Process, Autocorrelation, Long Memory, Volatility Clustering, Non-Parametric, Monte Carlo, Panic Copula, Elliptical

JEL Classification: C1, G11