LO 68.2: Describe the impact of horizon, turnover, and leverage on the risk

LO 68.2: Describe the impact of horizon, turnover, and leverage on the risk management process in the investment management industry.
The sell side of the investment industry largely consists of banks that have developed VaR techniques and have used them for many years. Investors make up the buy side of the investment industry. Investors are now using VaR techniques, but they have to adapt them to the different nature of that side of the business. To understand why the needs are different, we should compare the characteristics of the two sides. Figure 1 makes direct comparisons.
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2018 Kaplan, Inc.
Topic 68 Cross Reference to GARP Assigned Reading – Jorion, Chapter 17
Figure 1: Sell Side and Buy Side Characteristics
Horizon Turnover Leverage Risk measures
Risk controls
Sell Side
Buy Side
Short-term (days)
Long-term (month or more)
Fast High VaR
Stress tests
Position limits VaR limits Stop-loss rules
Slow Low
Asset allocation Tracking error Diversification Benchmarking
Investment guidelines
Banks trade rapidly, which is why they cannot rely on traditional measures of risk that are based on historical data. For banks, yesterdays risk may not have anything to do with todays positions. Investors usually try to hold positions for longer periods of time (e.g., years).
Having a more dynamic method for measuring risk such as VaR is also important for banks because of their high leverage. Institutional investors often have much stronger constraints with respect to leverage; therefore, they have a much lower need to control downside risk.
Th e In v e s t m e n t P r o c e s s