Financial Risk Management For Dummies by Brown Aaron;

Author:Brown, Aaron;
Language: eng
Format: epub
Publisher: Wiley
Published: 2015-10-09T00:00:00+00:00

Monitoring limits

Providing good tools for managing limits is as important as setting wise limits. The first important distinction among limits is how often they’re monitored. The common schemes, starting from the most rigorous are:

Continuous: Most people expect that setting a limit means that it’s continuously monitored and enforced, but people often find it impractical to monitor things continuously.

Pre-action: The limit is checked prior to taking any action that may cause a breach. This check can prevent active breaches, in which the action causes things to go over the limit, but it does nothing to prevent a passive breach, in which things go over limit due to market movements or other external causes.

Periodic: There is a periodic process, daily or some other frequency, to see whether the limit is satisfied. Exceptions can occur between checks. This ability may be a desired feature of the limit system – for example, traders are often allowed to take more risk during the trading day than they can hold overnight. Or the exception may be a bug in the system – an inability to monitor limits that combine things that trade in different time zones during the day, for example, because reliable portfolio valuations may become available only at end of the New York day, when most markets are closed.

Exception based: Limits are checked after an exception event such as a futures roll, in which futures contracts are taken off a near-term delivery date and replaced by longer term contracts, or a change in credit rating. This method works for limits that aren’t expected to fluctuate during the holding term, but only at the end of the process.

After problems: These conditional limits apply only after specified bad events such as portfolio losses beyond some level or a credit default.

Never: Avoid using this category. Better to not have a limit than to have a limit but never check it. However, these kinds of limits are surprisingly common. They exist only so that someone can point a finger afterwards.

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