Risk Management in Trading and Investment Portfolios: An Optimisation Algorithm for Maximum Risk-budgeting Threshold

The aim of this article is to bridge the gap in equity trading risk management literatures and particularly from the perspective of emerging and illiquid markets, such as in the context of the Gulf Cooperation Council (GCC) financial markets. In this article, we demonstrate a practical approach for the measurement and control of market risk exposure for financial trading portfolios that contain several illiquid equity securities during the unwinding (close-out) period. This approach is based on the renowned concept of Value-at-Risk (VaR) along with the development of an optimisation risk algorithm utilising matrix-algebra technique. Our thorough asset market risk modelling-algorithm can simultaneously handle VaR analysis under normal and severe market conditions, besides it takes into account the effects of illiquidity and short-sales of traded equity securities. In order to illustrate the proper use of VaR and stress-testing methods, real-world structured modelling techniques of trading risk management are presented for the GCC financial markets. To this end, comprehensive simulation case studies are accomplished with the objective of constructing a realistic framework for trading risk measurement and control in addition to the instigation of a risk optimisation algorithm-process for the computation of maximum authorised VaR risk-budgeting limits.