Market Risk Measure and Portfolio Optimization for managing Central Bank's Portfolio

Abstract

The main purpose of financial institutions is asset management. As a result, they are regularly faced with various risks. Central banks are not exempt. Taking into account the Bank of Central African States where we have asked for the first time the question on this topic, through its portfolio of assets that can in the context of the management of its foreign exchange reserves held by its Trading Room is exposed to financial risks, including market risk. In general, financial institutions can deal with market risk, credit risk and transaction risk. Over the past ten years, in accordance with all developments in financial intermediation, the perception and management of risks incurred by financial institutions has changed dramatically. As a result, there has been a significant change in risk assessment and risk management methods. The measurement and management of financial risk is thus one of the major problems within financial institutions since they interact on the financial market by carrying out transactions on post-balance sheet securities, forex, commodities, etc. In a simple way, market risk is defined as the risk of losses resulting from changes in market prices (stock prices, commodities, currencies and interest rates). Market risk is composed of several risks in its own right: liquidity risk, currency risk and interest rate risk. For several years, Value At Risk (VaR) has emerged as one of the market risk measures. It consists in estimating with a certain degree of precision (confidence level) the loss that can occur on an asset or on a portfolio of assets on a given horizon, for example 1 day, 10 days or 1 month, given an index selected confidence (95% or 99%). However, the Value at Risk estimate does not take into account the realization of extreme events that could arise and result in the loss of a portfolio. Hence the need to dig deeper into this area.