The term Market risk applies to
- that part of IRR which affects the price of interest rate instruments,
- Pricing risk for all other assets/ portfolio that are held in the trading book of the bank, and
- Foreign Currency Risk.
The risk of adverse deviations of the mark-to-market value of the trading portfolio, due to market movements, during the period required to liquidate the transactions is termed as Market Risk. This risk results from adverse movements in the level or volatility of the market prices of interest rate instruments, equities, commodities, and currencies.
It is also referred to as Price Risk.
Price is a market-driven measure of value. A seller will always want to sell at a higher (or highest) value in the market and a buyer will always want to buy at a lower (or lowest) price in the same market. In trying to achieving so; both the buyers and sellers may sometime delay in buying or selling – in expectation of the price going lower (for a Buyer) or expecting the price to go higher (from a seller’s perspective). This possibility of not realising the expected price may be called the Price risk.
Same situation may pose different risk to different people – depending on which role one is playing.
An onion farmer may be scared that the prices may go down when the final harvest is ready. Whereas a housewife may be thinking if the harvest if not good, the prices may go up. So at any point in time, we always have different sets of people having opposite views, thus helping discover ‘market price’.
Price risk can be classified into the following categories:
- Symmetrical risk – Unsymmetrical
- Absolute risk – Relative risk
- Asset liquidity risk
- Concentration risk
- Credit spread risk
- Volatility risk