A market risk analysis is the process of studying the risks that an investor’s portfolio faces in an effort to mitigate those risks. Different risks are associated with the different categories of securities, so it can be helpful for investors to study those risks closely, evaluating how likely their portfolios are to be exposed to specific threats, and how serious the impact would be if they were exposed. In addition, a market risk analysis should take into account the risks involved with various sectors of the market. Another way that this term is used is to describe the analysis that a business performs before venturing into a specific market for the first time.
When people think about investing, they often think in terms of the positive benefits of investing; after all, the purpose of investment is to make passive wealth grow. Investing also comes with the very real risk that a good deal of capital may be lost, though. To minimize the risks associated with normal investing, investors can perform — or hire a financial services professional to perform — a market risk analysis.
There are many different ways for a market risk analysis to be performed. Investment professionals often perform hypothetical stress tests to see how a portfolio would hold up in a worst-case scenario. Another popular tool is the "Value at Risk" calculation, or VaR, which uses the past price performance and inherent volatility of securities as a way of assessing portfolio risk. These and many other tools allow analysts to find out where portfolios are vulnerable and how they can be adjusted to compensate.
Each different class of securities is associated with a specific set of risks, and a market risk analysis, if performed effectively, can uncover these risks. For example, stocks are risky because the prices could plummet and thereby devalue the shares held by investors. By contrast, bond investors have to worry about the possibilities of issuing institutions defaulting or interest prices rising. Whatever the security, a risk analyst can parse through the risks involved and find ways to alleviate them.
Businesses might also take advantage of a different type of market risk analysis to find out whether expansion into a novel market is worth the risk involved. A company that is used to doing business in a specific area might not be aware of all of the issues attached to a new market. For that reason, a proper analysis can answer a lot of pertinent questions and provide peace of mind to company managers.