Published: May 18, 2011
We all know that correlation is a statistical method to express the relationship of data and their movements, for example, the movement of the EUR/USD-spot rate versus the price of oil. Or, in other words, correlation helps you to find out whether the total risk in your portfolio is less than the risk of all individual factors added together, because sometimes the price of one risk can go up more strongly than the price of another risk (or may even decline at the same time). Once you are calculating such effects you need to work out the correlations of all risk factors in your portfolio. This is the number-crunching part which needs to be done in a concise, secure and efficient way, and which we do for our clients for more than 1,000 risk factors by way of a daily, weekly or monthly individual service. These data are then imported into their treasury systems.
The result of this can be visualised in the new Portfolio-Risk-Index, a monthly index which Schwabe, Ley & Greiner (SLG) has started to publish.
The PRIX is a composite index integrating both traded financial and commodity risks. Imagine your company producing in the Eurozone and Hungary needing aluminium, pulp and plastics, electricity and oil. One-third of your sales is in USD and your bank debt is largely based on variable interest rates.The PRIX shows how these risks taken together – based on the exposures and considering their correlation – have developed over time.
In Figure 1, you can see how the company's total risk soared during 2008, declined until June 2010 – and then started to increase again.
In a second step you can relate this trend to your risk capacity, e.g., to an index reflecting your earnings before interest and tax (EBIT) (see Figure 2). You may note that your total risk has become proportionately even larger since your EBIT may have declined in the same time – thereby reducing your risk capacity. This should send an alarm signal to the CFO.[[[PAGE]]]
In a third step you could evaluate how far your hedging strategy helps to reduce your Portfolio-Risk-Index. Sometimes, though, you may note that ‘hedging a lot’ proves counter-productive by not significantly reducing the total risk but only increasing the fees paid to banks for the cost of maintaining the hedging programme. Less hedging or hedging only a few risk factors instead may prove more economic without risking your safety.
The PRIX provided by SLG is a useful instrument with which to visualise your portfolio risk. If you want to calculate your risks we can offer you the correlation data and the mathematics required. If you want to have your individual PRIX we will be pleased to assist you in constructing it.
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