Correspondence: Mazin A M Al Janabi, Department of Economics and Finance, College of Business and Economics, United Arab Emirates University, P.O. Box 17555, Al-Ain, United Arab Emirates. Tel: +(971) 3 7133384; Fax: +(971) 3 7624384; E-mail: m.aljanabi@uaeu.ac.ae

¹Mazin A. M. Al Janabi is Associate Professor of Finance and Banking and has several years of real-world experience in financial markets and banking sectors. He has worked for top international financial groups like ING-Barings (Dutch financial group) and BBVA-Bancomer (Spanish financial group), where he has held several senior positions, such as Head of Trading of Financial Derivative Products, Head of Trading Risk Management, Director of Asset and Liability Management and Director of Global Market Risk Management.

Received 8 December 2006; Revised 8 December 2006.

Abstract

This paper provides real-world techniques and optimum asset allocation strategies that can be applied to equity trading portfolios in emerging and illiquid financial markets. Key market risk management methods and procedures that financial entities, regulators and policymakers should consider in formulating their daily market risk management objectives are examined and are adapted to the specific needs of emerging countries. The aim of this paper is to fill a gap in the trading risk management literature and particularly from the perspective of emerging and illiquid markets, such as in the context of the Mexican financial markets. In this paper, we demonstrate a comprehensive and proactive approach for the measurement, management and control of equity trading risk exposure, which takes into account proper adjustments for the illiquidity of both long and short trading/investment positions under normal and severe market conditions and within a multi-security setting. Our approach is based on the renowned concept of Value-at-Risk (VAR) along with the innovation of a software tool utilising matrix-algebra and other optimisation techniques. To illustrate the proper use of VAR and stress-testing (scenario analysis) methods, real-world examples and practical reports of market risk management are calculated and presented for a selected portfolio from the Mexican Stock Market (BMV). To this end, several case studies were achieved with the objective of creating a realistic framework of trading risk measurement and control reports in addition to the inception of procedures for the calculation of the maximum authorised VAR limits.