Helen Hizhniakova and Tatiana Lozovaia* look at how to extend modern portfolio theory to make money from trading equity options
Every trader, market maker orc financial analyst knows what
risk is and knows the methods to estimate it.There are various
theories on how to estimate risk in the world of finance. We do
not endeavour in this article to evaluate some of the more
sophisticated theories of risk estimation. However, a brief
overview of what is probably the best known theory of
portfolio risk, Value at Risk (VaR), is warranted. VaR has
become so prevalent that it is almost impossible to find
profes- sionals in the financial markets that are not at least
remotely familiar with the measure.
What is commonly referred to asVaR, is the risk expressed in
dollar terms showing what amount of money a portfolio can lose
during a defined interval with a given probability. The terms
that are most commonly mentioned along with VaR (and are
similar in meaning to VaR) are dispersion, variance and
volatility. So,VaR is, in essence, the volatility of the
portfolio expressed in dollar terms. Beginning with the basics
of VaR analysis, we can demonstrate how this concept can be
applied not only to estimate the risks of a portfolio of assets
but also how this theory can be applied to trading the market
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