RiskMetrics

The RiskMetrics variance model (also known as exponential smoother) was first established in 1989, when Sir Dennis Weatherstone, the new chairman of J.P. Morgan, asked for a daily report measuring and explaining the risks of his firm. Nearly four years later in 1992, J.P. Morgan launched the RiskMetrics methodology to the marketplace, making the substantive research and analysis that satisfied Sir Dennis Weatherstone's request freely available to all market participants.

In 1998, as client demand for the group's risk management expertise exceeded the firm's internal risk management resources, the Corporate Risk Management Department was spun off from J.P. Morgan as RiskMetrics Group with 23 founding employees. The RiskMetrics technical document was revised in 1996. In 2001, it was revised again in Return to RiskMetrics. In 2006, a new method for modeling risk factor returns was introduced (RM2006). On 25 January 2008, RiskMetrics Group listed on the New York Stock Exchange (NYSE: RISK). In June 2010, RiskMetrics was acquired by MSCI.

Portfolio risk measurement can be broken down into steps. The first is modeling the market that drives changes in the portfolio's value. The market model must be sufficiently specified so that the portfolio can be revalued using information from the market model. The risk measurements are then extracted from the probability distribution of the changes in portfolio value. The change in value of the portfolio is typically referred to by portfolio managers as profit and loss, or P&L

Risk management systems are based on models that describe potential changes in the factors affecting portfolio value. These risk factors are the building blocks for all pricing functions. In general, the factors driving the prices of financial securities are equity prices, foreign exchange rates, commodity prices, interest rates, correlation and volatility. By generating future scenarios for each risk factor, we can infer changes in portfolio value and reprice the portfolio for different "states of the world".

The first widely used portfolio risk measure was the standard deviation of portfolio value, as described by Harry Markowitz. While comparatively easy to calculate, standard deviation is not an ideal risk measure since it penalizes profits as well as losses.

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