--- title: Chapter 10 Endogenous risk layout: default ---

Endogenous risk

  1. Define the terms endogenous and exogenous risk, and provide examples of each.

  2. The former general manager of the BIS, Andrew Crockett stated in 2000:

    “The received wisdom is that risk increases in recessions and falls in booms. In contrast, it may be more helpful to think of risk as increasing during upswings, as financial imbalances build up, and materialising in recessions.”

    How does his view on risk relate to endogenous risk, and what is the implication for governments’ policies on financial stability?

  3. It has been said that financial risk models are least reliable when needed them the most. Explain the statement.

  4. You run a Japan oriented hedge fund with a target leverage of five. You own stock in only one company, were the price of one stock is 20,000. The number of stocks in your portfolio is 10. Your hedge fund is very small and you have no price impact when you trade. Suppose the price of the stock falls by 1,000. Making all necessary assumptions, how many stocks would be left in your portfolio after the necessary rebalancing?

  5. Starting with the last question, suppose instead that your fund is large and exerts significant pricing power. In particular, for every 1,000,000 you trade, the price of the stock moves by 2,000 in the direction of the sale, (up if you buy, down if you sell). Suppose the price of the stock falls for exogenous reasons by the same amount as in question 4.a. Making all necessary assumptions, how many stocks would be left in your portfolio after the necessary rebalancing?

  6. Consider the price of a typical stock and the VIX index. Are they mean reverting?

  7. Recall the case of the LTCM hedge fund and its investment in the VIX. In the months before LTCM’s default, the VIX was steadily rising, causing more and more distress for LTCM. Describe in detail why the rising VIX caused the default of LTCM.