Introduction to the Infiniti Capital Four Moment Risk Decomposition

By Peter Urbani and Mitchell Bristow

One way to include the impact of higher moments into the calculation of Value at Risk (VaR) for such portfolios is to use the Cornish Fisher modification to the Normal VaR calculation. The empirical evidence indicates that only about 12% of Hedge Funds have returns that are normally distributed. Consequently the impact of higher moments is of great interest to people building portfolios of hedge funds or managing their risk. The Normal distribution can be full described by its first two moments. 2 .Higher Moments and Risk Classical Investment Theory assumes that investment returns are normally distributed. Hedge Fund returns exhibit significant amounts of skewness and excess ( > 3 ) kurtosis (third and fourth statistical moments). Investors generally have a preference for positive skewness and moderate to low levels of kurtosis. Mean (Mu) and Standard Deviation (Sigma).

Normal versus Modified VaR In the case of a standard normal distribution (Mean=0. Std Dev=1. Note this assumes Raw Kurtosis – Excels formula assumes Excess Kurtosis > 3 and subtracts 3 automatically. This is why Kurtosis is not 0 in the above example. 3 . Skew=0. Kurt=3) both the Normal Var and Cornish Fisher Modified VaR give the same answer.

Std Dev=1. Skew=0.Normal versus Modified VaR In the case of a slightly positive skewness and slightly higher than normal kurtosis (Mean=0. Kurt=4) the Cornish Fisher Modified VaR is lower (less negative) than that given by the Normal VaR calculation.5. 4 .

Std Dev=1. Kurt=4) the Cornish Fisher Modified VaR is higher (more negative) than that given by the Normal VaR calculation. 5 .Normal versus Modified VaR In the case of a slightly negative skewness and slightly higher than normal kurtosis (Mean=0.5. Skew=-0.

The Cornish Fisher Modification In Excel for use with Excess Kurtosis = (Skew*(ZScore^2-1)/6)+(Kurt*(ZScore^33*ZScore)/24)-((Skew^2)*(2*ZScore^3-5*ZScore)/36) for use with Raw Kurtosis =(1/6)*(ZScore^2-1)*Skew+(1/24)*((ZScore^3)3*ZScore)*(Kurt-3)-(1/36)*(2*Zscore^35*ZScore)*Skew^2 6 .

Moving from the Univariate to the Multivariate Weights Weights (normal) Variance Covariance Matrix Std Devs (normal) -> Correlation Matrix (normal) Variance -> Covariance Matrix Std Devs CoSkewn +ess (modified) -> Correlation Matrix Mod Std Devs CoKurtosis -> (normal) VaR -> (modified) VaR 7 .

Infiniti Capital Modified VaR Decomposition 8 .

Normal & Modified VaR for a portfolio 9 .

Basic Portfolio Statistics 10 .

Covariance Matrix 11 .

‘Modified’ Covariance Matrix 12 .

Correlation Matrix 13 .

‘Modified’ Correlation Matrix 14 .

‘Modified’ Volatility 15 .

Normal & Modified VaR from these Matrices 16 .

Infiniti Capital Four Moment Risk Decomposition 17 .infiniti-analytics.

4% to the return. Whilst the differences between the Normal and Modified VaR for individual positions may be small in some cases. This is even more evident when we look at the Modified Conditional VaR (Modified CVaR) versus the Normal CVaR of -4.90%. Convertible Arbitrage. 18 .56%.51 contribute to the 95% Modified VaR being higher than the Normal VaR at -2.28% versus -1.0% to the Risk (Modified CVaR). Comparatively Emerging Markets was far riskier as although it contributed 19.a expected shortfall (ES)) tend to be far more pronounced.What can we learn from this Analysis ? First we can see that the portfolio’s negative Skew of -1.3% to return.28 and excess Kurtosis of +4. it also contributed 39. Thus we can see that largest % Contributions to the portfolio’s Modified CVaR came from Emerging Markets.09% versus -2. it also contributed 18. However when we look at ratio of % Contribution to Weight we can see that although Distressed contributed 18.k. those for the Normal and Modified CVaR (average tail expectation beyond the VaR a.6% to the Risk. Event Driven and Distressed.

tax.    If a financial instrument is denominated in a currency other than an investor’s currency.    Past performance is not guarantee of. a change in exchange rates may adversely affect the price or value of.  It is not an offer or solicitation to enter into any agreement or contract with Infiniti.  Infiniti has no obligation to update. or any opinion. correctness.    Infiniti (i) may be a market maker or specialist in securities issued by companies mentioned herein (ii) may act as an adviser. modify or amend this publication or to otherwise notify a reader in the event that any matter stated herein.   The information contained herein is intended for illustrative purposes only.Disclaimer The information and opinions in this presentation were prepared by the Infiniti Group (collectively “Infiniti”). accuracy reasonableness or completeness of the information and opinions herein but has obtained the information from sources believed to be reliable. and the value of such instruments may be highly volatile.    The information contained herein is CONFIDENTIAL. future results. the terms of the Fund Documents shall prevail.  Transactions of the type described herein may involve a high degree of risk.  Any opinions expressed herein reflect Infiniti’s judgment at the date and time hereof and are subject to change without notice.  Prices and availability of any financial instruments described in this presentation are subject to change without notice.  An offer may only be made by means of the offering memorandum and governing documents of the relevant funds (the “Fund Documents”). simulations.  In the event the Information is inconsistent or contrary to the descriptions or terms of the Fund Documents. has been developed internally and has been based on variations of existing funds. projection.   Infiniti is not acting and does not purport to act in any way as your advisor. credit.  It is intended only for the use of the person to whom this document is given and may not be reproduced or redistributed in whole or in part without the prior written consent of Infiniti. rate or other market or economic measure as past performance is not necessarily indicative of future results.    Analyses contained herein are based on assumptions that if altered can change the conclusions reached herein. although no warranty is made that the information is accurate or complete and it should not be relied upon as such. accounting and regulatory issues relating to the merits or otherwise of the products and services discussed. or the income derived from. underwriter or lender to companies mentioned herein (iii) may have received or intend to seek compensation for investment services from companies mentioned herein (iv) along with its respective officers. and cannot be construed as an indication of. and any investor in that financial instrument effectively assumes currency risk. managed accounts.  Whilst all reasonable care has been taken to ensure that the facts stated herein are accurate and that the opinions and expectations contained herein are fair and reasonable. forecast or estimate set forth herein. pro forma data or taken from trade and statistical services and other sources that we deem reliable.  Financial instruments that may be discussed herein may not be suitable for all investors and any investors must make any investment decision using their own independent advisors as they believe necessary and based upon their specific financial situation and investment objectives.   19 .  This presentation is provided for information purposes only.  The information is not intended to be complete or final and is qualified in its entirety by the Fund Documents.   Any securities discussed herein may not be suitable for all investors.  The information is not intended to depict or predict actual investment performance of any financial product and is subject to change without notice. currency.  Nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument. with respect to the fairness. Infiniti makes no representation or warranty.  We therefore strongly suggest that you seek your own independent advice in relation to any legal. which should be read in their entirety. or the solicitation of an offer to buy. the financial instrument.      This does not constitute an offer to sell. express or implied. extrapolations of other investment programs. any product. directors and employees may affect transactions and/or hold long or short positions in the underlying securities or related financial products of companies mentioned herein. changes or subsequently becomes inaccurate.

Sign up to vote on this title
UsefulNot useful