This paper was partly written when AJM was visiting researcher at GSB Stanford University and Wharton School. Support from the Tinbergen Institute and KLM Royal Dutch Airlines is gratefully acknowledged. We would like to thank our colleagues at the KLM Royal Dutch Airlines, the Tinbergen Institute Rotterdam, the referee (Giovanni Barone-Adesi), Ton Vorst, Simon Benninga, and participants at the EFA, EFMA and QMF conferences for their helpful comments and suggestions. We acknowledge the support of Leading Market Technologies technical desk in creating the software tools. Correspondence: Albert J. Menkveld.
Analysing Perceived Downside Risk: the Component Value-at-Risk Framework
Version of Record online: 12 NOV 2004
European Financial Management
Volume 10, Issue 4, pages 567–591, December 2004
How to Cite
Hallerbach, W. G. and Menkveld, A. J. (2004), Analysing Perceived Downside Risk: the Component Value-at-Risk Framework. European Financial Management, 10: 567–591. doi: 10.1111/j.1354-7798.2004.00266.x
- Issue online: 12 NOV 2004
- Version of Record online: 12 NOV 2004
- factor models;
- risk decomposition
Multinational companies face increasing risks arising from external risk factors, e.g. exchange rates, interest rates and commodity prices, which they have learned to hedge using derivatives. However, despite increasing disclosure requirements, a firm's net risk profile may not be transparent to shareholders. We develop the ‘Component Value-at-Risk (VaR)’ framework for companies to identify the multi-dimensional downside risk profile as perceived by shareholders. This framework allows for decomposing downside risk into components that are attributable to each of the underlying risk factors. The firm can compare this perceived VaR, including its composition and dynamics, to an internal VaR based on net exposures as it is known to the company. Any differences may lead to surprises at times of earnings announcements and thus constitute a litigation threat to the firm. It may reduce this information asymmetry through targeted communication efforts.