Risk & Portfolio

78 Risk & Portfolio terms, defined in plain English — part of the 1345-term Finicade finance glossary. Each one has its own page, and links to the free game that teaches it.

Alpha: The return a manager delivers beyond what their market risk (beta) would explain — genuine skill, if it's real and repeatable.
Arbitrage Pricing Theory (APT): Arbitrage pricing theory says expected return is driven by several systematic factors, with no-arbitrage forcing the relationship rather than preferences.
Backtesting: Checking a model or strategy against history — did the losses that actually happened line up with what the model predicted?
Basel Rules: The global bank-regulation framework setting how much capital banks must hold against their risks.
Basis Risk: The risk that a hedge and the thing it's hedging don't move perfectly together, leaving a residual loss.
Beta: How much a stock tends to move relative to the whole market.
Calmar Ratio: The Calmar ratio divides annualised return by maximum drawdown, judging a strategy by the worst loss investors actually had to sit through.
Capital Market Line: The capital market line joins the risk-free asset to the tangency portfolio, showing the best return available at each level of total risk.
CAPM (Capital Asset Pricing Model): The classic model for the return an asset should offer: the risk-free rate plus its beta times the market's risk premium.
Coherent Risk Measure: A risk measure that behaves sensibly — most importantly, that says a diversified portfolio is never riskier than its parts (subadditivity).
Concentration Risk: Concentration risk is the exposure that comes from a portfolio depending too heavily on one position, sector, counterparty or region.
Correlation: How closely two assets move together, on a scale from +1 (in lockstep) through 0 (unrelated) to −1 (opposite).
Counterparty Risk: The risk the other side of a trade won't honour their end — a live worry in bespoke, off-exchange contracts like forwards and swaps.
Country Risk: Country risk is exposure that comes from where an asset sits rather than what it is: expropriation, capital controls, war, or a government that stops paying.
Covariance: The raw measure of whether two assets move together, before it's scaled into a tidy −1-to-+1 correlation.
Credit Risk: The risk a borrower fails to pay you back.
Currency Risk: Currency risk is the effect of exchange rate moves on the value of a foreign asset or cash flow measured in your own currency.
Default: When a borrower fails to make a payment they owe.
Downside Deviation: Downside deviation measures only the variation below a chosen threshold, ignoring upside swings entirely.
Drawdown: The drop from a portfolio's peak to its subsequent trough — how deep the hole got before recovery.
Economic Capital: The cushion of capital a firm decides it needs to survive severe losses at a chosen confidence — its own internal, risk-based answer to 'how much is enough?'.
Efficient Frontier: The set of portfolios that squeeze the most expected return out of each level of risk.
Efficient-Market vs Factors: Factor models explain returns by exposure to broad drivers — the market, size, value, momentum — rather than luck.
EWMA: Exponentially weighted moving average — a volatility estimate that weights recent returns more heavily than old ones, so it reacts quickly when markets turn.
Expected Shortfall (CVaR): The average loss in the bad cases beyond the Value-at-Risk cutoff — it answers 'if things go worse than VaR, how bad on average?'.
Extreme Value Theory: Extreme value theory models the tail of a distribution directly rather than fitting the whole thing and hoping the tail follows.
Fama-French Three-Factor Model: The Fama-French model explains returns with three factors — the market, company size, and value versus growth — after CAPM single factor failed tests.
Fat Tails: The tendency for extreme moves — crashes and spikes — to happen far more often than a bell curve predicts.
Gap Risk: The danger that a price jumps straight through your stop or hedge level without trading there — leaving losses bigger than the model assumed.
GARCH: A model that captures volatility clustering — the way calm and stormy periods bunch together — by letting today's variance depend on yesterday's.
Historical Simulation: Historical simulation computes risk by revaluing today portfolio under every past market move in a window, then reading the loss percentile off it.
Historical Volatility: How much an asset actually moved in the past, measured as the standard deviation of its returns.
Inflation Risk: Inflation risk is the chance that rising prices erode the real value of your money or your fixed income stream.
Information Ratio: A manager's excess return over a benchmark divided by their tracking error — reward per unit of active risk.
Interest Rate Risk: Interest rate risk is the loss from rates moving against a position — falling bond prices when yields rise, or funding that reprices faster than assets.
Jensen's Alpha: Jensen's alpha is the return a portfolio earned beyond what CAPM says its beta deserved.
Kurtosis: Kurtosis measures how much of a distribution's variance comes from rare extreme observations rather than ordinary ones.
Liquidity Risk: The risk you can't sell fast enough without crashing the price, or can't fund your positions when cash dries up.
Minimum Variance Portfolio: The minimum variance portfolio is the combination of assets with the lowest possible volatility — the leftmost point of the efficient frontier.
Model Risk: The risk that your model is simply wrong — bad assumptions, bad calibration, used outside its limits.
Momentum Factor: Momentum is the tendency for assets that performed well over the past 3–12 months to keep outperforming over the next few.
Operational Risk: The risk of loss from failed processes, systems, people or outright fraud — rogue traders, botched trades, cyber-attacks.
Parametric VaR: Parametric VaR assumes returns are normally distributed and computes risk directly from volatilities and correlations.
Portfolio Variance: The total risk of a portfolio, built from each holding's variance plus every pair's covariance.
RAROC: Risk-adjusted return on capital — profit measured against the economic capital a business ties up to cover its risks.
Realized Volatility: Realized volatility is the volatility an asset actually delivered over a period, computed from observed returns.
Recovery Rate: The fraction of a defaulted loan or bond that creditors actually get back.
Reinvestment Risk: Reinvestment risk is the danger that coupons and maturing principal must be reinvested at lower rates than the original investment earned.
Reverse Stress Testing: Reverse stress testing starts from failure and works backwards: what set of events would make this firm non-viable?
Risk Appetite: Risk appetite is the amount and type of risk a firm's board has decided it is willing to take in pursuit of its strategy.
Risk Budgeting: Deciding in advance how much risk each desk, strategy or asset is allowed to consume, then allocating within that limit.
Risk Parity: Risk parity allocates so each asset contributes equally to portfolio risk, rather than equal dollars.
Risk Premium: The extra return investors demand for holding something risky instead of a safe asset.
Risk Taxonomy: The standard filing system for risk — market, credit, liquidity, operational and the rest.
Risk-Free Rate: The risk-free rate is the return available with no credit risk, proxied in practice by short-term government debt in the same currency.
Safe Haven: A safe haven is an asset investors buy when they are frightened, which is defined by behaviour in crises rather than by any intrinsic property.
Scenario Analysis: Asking 'what happens to my portfolio if…' — a rate shock, a currency crisis, a 2008 rerun — and pricing the answer.
Security Market Line: The security market line plots expected return against beta, and under CAPM every fairly priced asset sits exactly on it.
Sharpe Ratio: Return earned per unit of risk taken: an investment's excess return over cash, divided by its volatility.
Skewness: Whether a distribution leans one way — a long tail of big losses (negative skew) or big gains (positive skew).
Smart Beta: Smart beta packages factor exposures — value, momentum, quality, low volatility, size — into rules-based index funds priced between passive and active.
Sortino Ratio: A twist on the Sharpe ratio that only counts downside volatility, not the harmless upside kind.
Standard Deviation: How spread out a set of numbers is around their average — in finance, the standard measure of volatility.
Stress Testing: Deliberately running a portfolio through brutal hypothetical scenarios — a 2008 rerun, a rate spike — to see what would break.
Systematic Risk: The market-wide risk you can't diversify away — recessions, rate shocks, crises that drag almost everything down together.
Systemic Risk: Systemic risk is the danger that one institution failure cascades into collapse of the wider system, through exposures, fire sales and lost confidence.
Tail Risk: The risk of rare, extreme losses out in the far tail of the distribution — the crashes that ordinary models treat as almost impossible but that keep happening.
Three Lines of Defense: The three lines of defense assigns risk ownership to the business, oversight to risk and compliance, and independent assurance to internal audit.
Tracking Error: How far a portfolio's returns stray from its benchmark, measured as the standard deviation of the difference.
Treynor Ratio: The Treynor ratio measures excess return per unit of beta, rather than per unit of total volatility as Sharpe does.
Unsystematic Risk: The risk specific to one company or sector — a scandal, a failed product, a factory fire.
Value at Risk (VaR): A single number summarising downside: the most you'd expect to lose over a set period at a given confidence, say '1% chance of losing more than $1m in a day'.
VaR Decomposition: Breaking a portfolio's Value at Risk into where it comes from — which positions add risk (component and marginal VaR) and which offset it.
Variance: The average of the squared distances from the mean — standard deviation before you take the square root.
Volatility: How much an asset's price swings, usually quoted as an annualised percentage.
Volatility Clustering: Volatility clustering is the observation that turbulent days follow turbulent days and calm follows calm.
Wrong-Way Risk: When your exposure to a counterparty grows at exactly the moment they're most likely to default — the two risks moving together, badly.
Z-Score: How many standard deviations a value sits from the average.

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