A Primer on Risk Measurement Tools: Insights on their Uses, Importance and Shortcomings

Goldman Sachs Strategic Research, May 2007

38 Pages Posted: 27 Sep 2011 Last revised: 3 Apr 2016

Date Written: May 1, 2007

Abstract

For any given level of risk, investors generally aspire to engage in as many profit making opportunities as possible. “Risk” is the fuel source that makes profits possible. Yet, like any fuel source, risk should come with a warning label. It can be used to warm one’s house or to burn it down. Since risk is essential to returns but potentially damaging if misapplied, investors need to understand, manage and use it as intelligently as possible.

Because of its importance, investors are often presented with a great deal of risk information, primarily designed to help them understand the sources of returns and loss potential in their portfolios. Sorting through this information can be quite a challenge. At Goldman Sachs Asset Management, we recognize that there are many possible risk measures that can be used to quantify any number of portfolio risks, including market risk, credit risk, operational risk and liquidity risk.

We believe that no single metric, on its own, comprehensively measures the constellation of risks that investors face. Depending on the circumstance, different risk measures may be more or less appropriate. For this reason, one can gain clearer insights into portfolio risk by generating a variety of risk measures.

By writing this paper, we hope to help you sort through the plethora of risk information available. We have a simple objective: to improve the quality of the discussions between our clients and ourselves, and to help our clients better understand the “fuel sources” that drive the risks and returns in their portfolios. This paper is not an exhaustive discussion of all sources of risks faced by investors and related risk measures. Rather, our more modest goal is to describe some of the more frequently used risk measures and shed light on their strengths and weaknesses. In doing so, we provide a framework to evaluate and interpret some of the more commonly used risk measures.

Keywords: Risk Management, Risk Measurement

Suggested Citation

Rosengarten, Jacob D and Sun, Le, A Primer on Risk Measurement Tools: Insights on their Uses, Importance and Shortcomings (May 1, 2007). Goldman Sachs Strategic Research, May 2007. Available at SSRN: https://ssrn.com/abstract=1906933

Jacob D Rosengarten

XL Capital Ltd. ( email )

Hamilton HM 11
Bermuda

Le Sun (Contact Author)

Invesco Advisers, Inc.

United States

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