Journal of Risk

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Performance measures adjusted for the risk situation (PARS)

Christoph Peters and Roland C. Seydel

  • Notion of risk depends on the situation of the institution (ie, cash flows and preferences)
  • We introduce and advocate PARS (Performance measures Adjusted for the Risk Situation)
  • PARS shall measure the financial performance in the actual quantity of interest
  • Well-chosen PARS exhibit the right risk behavior instantaneously

Nowadays it is widely recognized that, to assess the performance of a fund or trading business, the risk associated with the trading strategy has to be considered as well; frequently, so-called risk-adjusted performance measures are employed. But what is risk? In this paper, we argue that risk should not always be measured in terms of the variability of the portfolio present value; rather the notion of risk generally depends on the financial situation of the institution in question, in terms of the size and time of future cashflows including (financial) consumption preferences. To this end, we introduce performance measures adjusted for the risk situation (PARS), which will measure the financial performance in the actual quantity of interest. Due to the effected risk transformation, PARS have zero volatility under the investment strategy replicating these future cashflows. We give several examples of cashflow structures for individuals and companies, showing how their PARS could be defined. In the context of a debt manager, we show the results from applying PARS to the dynamic control of bond portfolios via sensitivities.

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