The RiskMetrics variance model (also known as exponential smoother) was first established in 1989, when Sir Dennis Weatherstone, the new chairman of J.P. Morgan, asked for a daily report measuring and explaining the risks of his firm.
Nearly four years later in 1992, J.P. Morgan launched the RiskMetrics methodology to the marketplace, making the substantive research and analysis that satisfied Sir Dennis Weatherstone's request freely available to all market participants.
On 25 January 2008, RiskMetrics Group listed on the New York Stock Exchange (NYSE: RISK).
While comparatively easy to calculate, standard deviation is not an ideal risk measure since it penalizes profits as well as losses.
To measure the effect of changing positions on portfolio risk, individual VaRs are insufficient.
Subadditivity is required in connection with aggregation of risks across desks, business units, accounts, or subsidiary companies.
Lack of subadditivity could also be a matter of concern for regulators, where firms might be motivated to break up into affiliates to satisfy capital requirements.
Translation invariance Adding cash to the portfolio decreases its risk by the same amount.
RiskMetrics assumes that the market is driven by risk factors with observable covariance.
The risk factors are represented by time series of prices or levels of stocks, currencies, commodities, and interest rates.
These perturbed risk factor price scenarios are used to generate a profit (loss) distribution for the portfolio.
This method has the advantage of simplicity, but as a model, it is slow to adapt to changing market conditions.
The third market model assumes that the logarithm of the return, or, log-return, of any risk factor typically follows a normal distribution.
Monte Carlo algorithm simulation generates random market scenarios drawn from that multivariate normal distribution.
A related method called “Value-at-Risk,” which relies on the quantitative measurement of risk, has been spreading.