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Measuring and Managing Risk in Innovative Financial Instruments

by Stuart M. Turnbull of the University of Houston

May 18, 2009

Abstract: This paper discusses the difficult challenges of measuring and managing risk of innovative financial products. To measure risk requires the ability to first identify the different dimensions of risk that an innovation introduces. The list of possible factors is long: model restrictions, illiquidity, limited ability to test models, product design, counterparty risk and managerial related issues. For measuring some of the different dimensions of risk the implications of limited available data must be addressed. Given the uncertainty about model valuation, how can risk managers respond? All parties within a company - senior management, traders and risk managers - have important roles to play in assessing, measuring and managing risk of new products.

Published in: Journal of Credit Risk, Vol. 5, No. 2, (Summer 2009), pp. 87-114.

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