Exercise Solution 12.1

  1. Commercial real estate is illiquid and cannot be market to market on a daily basis. The problem is not that it will be difficult to implement value-at-risk for the commercial real estate. Rather, it will not be meaningful to do so. See the discussion of market risk in Section 1.3. In this circumstance it might be best to implement value-at-risk for just the equity and fixed income portions of the portfolio and address risk in the real estate portion with other tools.
  2. If the firm calculates value-at-risk daily at the end of each day, it will not reflect the significant risk being taken during each day. Solutions might be to calculate value-at-risk at multiple times throughout the trading day, or to calculate value-at-risk daily but to do so based on the portfolio’s composition at mid-day.
  3. Since IPOs have just been brought to market, there will be no historical market data for them. Some workaround will have to be used.
  4. This raises the same issue as in item (b) above. Because the paintings cannot be marked to market with any frequency, they do not entail market risk. Value-at-risk in inapplicable.

 

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