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In the risk model industry factors carry about half the explanatory power after the market effect is accounted for. However, Rosenberg had left unsolved how the industry groupings should be defined – choosing to rely simply on a conventional set of industries. Defining industry sets is a problem in taxonomy.
[85] [86] While hedging can reduce some risks of an investment it usually increases others, such as operational risk and model risk, so overall risk is reduced but cannot be eliminated. According to a report by the Hennessee Group, hedge funds were approximately one-third less volatile than the S&P 500 between 1993 and 2010. [87]
Another approach to model risk is the worst-case, or minmax approach, advocated in decision theory by Gilboa and Schmeidler. [22] In this approach one considers a range of models and minimizes the loss encountered in the worst-case scenario. This approach to model risk has been developed by Cont (2006). [23]
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Learn how to make better investment decisions based on the risk level that's right for you.
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Financial risk modeling is the use of formal mathematical and econometric techniques to measure, monitor and control the market risk, credit risk, and operational risk on a firm's balance sheet, on a bank's accounting ledger of tradeable financial assets, or of a fund manager's portfolio value; see Financial risk management.
[1] [2] See Finance § Risk management for an overview. Financial risk management as a "science" can be said to have been born [3] with modern portfolio theory, particularly as initiated by Professor Harry Markowitz in 1952 with his article, "Portfolio Selection"; [4] see Mathematical finance § Risk and portfolio management: the P world.