Abstract
This chapter presents an overview of risk management and portfolio management during the development of trading and investment system. The primary difference between the classical view of risk and the risk faced in the systematic trading/investment world is that while the former attempts to manage a person such as a trader or portfolio manager, the latter relates to manage the risk associated with a machine, which has predetermined performance and predetermined risk/reward ratios. In this stage, a product team is not involved anymore and in their place, risk managers and a kaizen team assumes control of the system. Risk managers will monitor the system's outputs and the kaizen team will make and/or implement containments, which are short-term solutions, not fixes or corrective actions, investigate root causes, and make recommendations for long-term fixes of the root cause. The machine has predetermined performance and predetermined risk/reward ratios, which are stochastic outputs that should be monitored by using SPC. The purpose of SPC is to notify risk managers of a problem in the machine, to make them aware of special, unassigned but assignable, variation in the system. The task of the risk managers and the product team, then, is to determine the root cause of the special variation in the performance of the machine. The demands on a risk manager are naturally more complex, as he has to be a part of a continuous improvement team, which is tasked by the management to fix trading/investment machines. Some of the deliverables used in this stage include return attribution and risk attribution report, root cause analysis reports, and identification of future risk distributions.
Published Version
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