Making forecasts more holistic – defining a framework for risk analysis
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Making forecasts more holistic –DEFINING A FRAMEWORK FOR RISK ANALYSIS
Bob Thompson, RETRI GroupSotiris Tsolacos, PPR
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Boom times
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Autumn economic forecasts 2006-2008: solid growth and unemployment and deficits falling
EU press release 6/11/2006
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But then………
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Risk assessment
Market risk
Indirect
Rating agencies
Direct
Market Actors
Asset specific risk
Indirect
Rating agencies
Direct
Market Actors
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Time to rein in the rating agencies
Brussels to reveal rating agency plansBanks’ links with rating agencies probedSenators accuse rating agencies of conflicts of interest in market turmoil
S.E.C. Criticizes Ratings Agencies’ Conflicts of InterestThe great credit rating scandal
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Forecasts
Model-based
projection
Future demand
proxy
Demand data
Supply data
Returns data
Estimate of future
supply
FORECASTJudgement
Implied market risk
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What can the fund manager do with a forecast?
• Use it to wow the investment committee
• File it away
• Use it as one input to further analysis of the asset/ portfolio
If things turn out well he is a genius, if things go badly the forecaster can be blamed
The investment decision has already been taken over lunch
Explore different market risk scenarios and make a more rounded decision
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We need a model that:
• Takes forecasts as inputs• Treats market risk objectively• Applies judgement in a structured and explicit way• Removes the influence of any optimism bias
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Forecast
Political
Economic
Social
Technological
Legislative
Environmental
PESTLE risk framework
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Model
• Balanced scorecard• Consultation on structural weights• Potential for crowdsourcing of time weights
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Summary
• Lessons from the recession :– Market risk is real– Outsourcing the analysis doesn’t solve the problem– Structured, documented, holistic analysis is required
• Work in progress – next step build the model!