**2.1. The role of stock market indexes**

In the economic literature, the stock exchange is often characterized as being a true "engine" of the economic life, which stimulates business activity and allows the development of large-scale investment projects. Through its existence and operation, the stock markets provide liquidity for financial assets, enabling the sale of securities previously purchased, thus turning them to money. Economic and financial crisis that has monopolized economies worldwide in recent years has had a negative impact on the development of stock markets. Thus, stock prices of large companies listed on stock exchanges fell dramatically, the liquidity of stock markets fell heavily, and on this basis, the transaction volume decreased due to the reduction of interest shown by investors and speculators. Indexes saw an overall decrease and *a distortion of information provided to potential investors because of "interference" occurred in the structure of the companies participating in their training*. By their developments, stock market indices are able to provide clues on the economic outlook whereas in countries with developed financial markets, leading companies have almost without exception status of listed companies. Thus, the indices themselves may be true barometers of economic development or they may be included in the calculation of aggregate economic indicators, with a high degree of complexity.

Risk Management on the Romanian Capital Market 331

 those who appreciate more weighted index say that the only way to avoid unwanted situation in which the relative change in price of shares issued by a company small in size will influence the stock index as much value as a change in the same type of the

Another issue that arises is the choice of the weighting factor. In theory there may be

In the first case there is a risk that a relatively small number of companies - which have a market capitalization way above the market average - will decide the meaning and scope of developments in practice the whole index. It is a common situation in emerging markets. Therefore, it is often set a maximum level of the share capitalization of a single symbol that

In practice, the liquidity is the most common alternative criterion to using market capitalization as the weighting factor. Attractiveness of the weighted indices to the liquidity lies in the idea that virtually any listed price of a share is a fiction as long as it materializes through a stock transaction. Therefore, prices become relevant only insofar as they are the result of a large number of transactions, which require (at least at first) the use of liquidity as a weighting factor in calculating the indices. The disadvantage of using liquidity as a weighting factor consists, however, in the presence of many differences from one day to another in the number of shares made with a specific symbol, which significantly alter its

In principle, a stock index is a tool for measuring aggregate price developments for the symbols which compose it, the sole result of supply-demand ratio of the market and the continuing process of reassessment of the price of each symbol individually [6-8]. Therefore is needed to incorporate the adjustment coefficients in the formula for calculating an index, allowing

events which directly affect the trading price of a symbol: the provision of dividends,

 events that influence the number of shares taken into account: the change in share capital by increasing / reducing the number of the outstanding shares, split face value,

changes in the composition of a stock index: the inclusion of a new symbol, a symbol of

Payment of the dividends or issuing of preference rights involves reducing the value of traded shares of a company, unless the subscription rights have value "zero" or negative. When providing payment of dividends and share trading, price decrease is due to reducing the company's value by the amount allocated for dividends, while the rights issue of preference allocation occurs due to the decreased value of the company on a number of shares. These decreases in market value of a share are fully balanced by increasing the same

correction of artificial effects induced by certain events on the trading price of a symbol:

strengthening the nominal value, granting free shares (bonus issues).

various options for the weighting factors, but in practice have won two:

weighting the liquidity of the shares that make up a stock index.

influence in the evolution of the overall index [4-5].

granting of rights to subscribe.

exclusion.

weighting by market capitalization (or the amount of the outstanding shares);

can play in the total capitalization of the symbols in the composition of a stock index.

share price "Blue Chips".

Expressing the overall performance of stock markets or simply of a sector of the market, indices allow investors to perform analysis on yields of already performed transactions or on investment opportunities that may arise in the future. The existence of indices make the analysis of various stock markets much easier, even if the different methodologies used for calculating the indices affect to some extent the comparisons accuracy [1-3].

On any stock market, the indices are a reference for each investor when assessing the quality of the management portfolio. Due to the fact that in many cases individual performance fail to exceed indices' long-term growth rate, investors and fund managers especially were tempted to build their own portfolios using the precise structure and composition of the indices.

#### **2.2. Critical elements in building and managing indexes**

A first issue to be solved when considering the desirability of launching a stock index is if you choose to use a formula in the category of arithmetic or geometric average. Since the use of geometric replication creates difficulties when the stock index would be eligible as underlying for derivatives or as a benchmark for investment fund, managers will prefer to use a formula based on the arithmetic average.

Also, the option to use weights in the calculation of indices involves an analysis of market characteristics to be described by the respective stock market index. The decision to weight the prices which is part of an index is itself a controversial:

 the supporters of the unweighted variant believe that such an index only ensures equal treatment of each stock symbol which is part of an index;

 those who appreciate more weighted index say that the only way to avoid unwanted situation in which the relative change in price of shares issued by a company small in size will influence the stock index as much value as a change in the same type of the share price "Blue Chips".

Another issue that arises is the choice of the weighting factor. In theory there may be various options for the weighting factors, but in practice have won two:


330 Risk Management – Current Issues and Challenges

with a high degree of complexity.

**2.1. The role of stock market indexes** 

**2. Risk assessment of stock market indexes** 

In the economic literature, the stock exchange is often characterized as being a true "engine" of the economic life, which stimulates business activity and allows the development of large-scale investment projects. Through its existence and operation, the stock markets provide liquidity for financial assets, enabling the sale of securities previously purchased, thus turning them to money. Economic and financial crisis that has monopolized economies worldwide in recent years has had a negative impact on the development of stock markets. Thus, stock prices of large companies listed on stock exchanges fell dramatically, the liquidity of stock markets fell heavily, and on this basis, the transaction volume decreased due to the reduction of interest shown by investors and speculators. Indexes saw an overall decrease and *a distortion of information provided to potential investors because of "interference" occurred in the structure of the companies participating in their training*. By their developments, stock market indices are able to provide clues on the economic outlook whereas in countries with developed financial markets, leading companies have almost without exception status of listed companies. Thus, the indices themselves may be true barometers of economic development or they may be included in the calculation of aggregate economic indicators,

Expressing the overall performance of stock markets or simply of a sector of the market, indices allow investors to perform analysis on yields of already performed transactions or on investment opportunities that may arise in the future. The existence of indices make the analysis of various stock markets much easier, even if the different methodologies used for

On any stock market, the indices are a reference for each investor when assessing the quality of the management portfolio. Due to the fact that in many cases individual performance fail to exceed indices' long-term growth rate, investors and fund managers especially were tempted

A first issue to be solved when considering the desirability of launching a stock index is if you choose to use a formula in the category of arithmetic or geometric average. Since the use of geometric replication creates difficulties when the stock index would be eligible as underlying for derivatives or as a benchmark for investment fund, managers will prefer to

Also, the option to use weights in the calculation of indices involves an analysis of market characteristics to be described by the respective stock market index. The decision to weight

the supporters of the unweighted variant believe that such an index only ensures equal

to build their own portfolios using the precise structure and composition of the indices.

calculating the indices affect to some extent the comparisons accuracy [1-3].

**2.2. Critical elements in building and managing indexes** 

use a formula based on the arithmetic average.

the prices which is part of an index is itself a controversial:

treatment of each stock symbol which is part of an index;

In the first case there is a risk that a relatively small number of companies - which have a market capitalization way above the market average - will decide the meaning and scope of developments in practice the whole index. It is a common situation in emerging markets. Therefore, it is often set a maximum level of the share capitalization of a single symbol that can play in the total capitalization of the symbols in the composition of a stock index.

In practice, the liquidity is the most common alternative criterion to using market capitalization as the weighting factor. Attractiveness of the weighted indices to the liquidity lies in the idea that virtually any listed price of a share is a fiction as long as it materializes through a stock transaction. Therefore, prices become relevant only insofar as they are the result of a large number of transactions, which require (at least at first) the use of liquidity as a weighting factor in calculating the indices. The disadvantage of using liquidity as a weighting factor consists, however, in the presence of many differences from one day to another in the number of shares made with a specific symbol, which significantly alter its influence in the evolution of the overall index [4-5].

In principle, a stock index is a tool for measuring aggregate price developments for the symbols which compose it, the sole result of supply-demand ratio of the market and the continuing process of reassessment of the price of each symbol individually [6-8]. Therefore is needed to incorporate the adjustment coefficients in the formula for calculating an index, allowing correction of artificial effects induced by certain events on the trading price of a symbol:


Payment of the dividends or issuing of preference rights involves reducing the value of traded shares of a company, unless the subscription rights have value "zero" or negative. When providing payment of dividends and share trading, price decrease is due to reducing the company's value by the amount allocated for dividends, while the rights issue of preference allocation occurs due to the decreased value of the company on a number of shares. These decreases in market value of a share are fully balanced by increasing the same

amount of portfolio investors as a result of amounts received as dividends or the sale of preference rights indices as a result of the above events has the advantage of simplicity, though in practice most indices are adjusted when there are such price changes.

Risk Management on the Romanian Capital Market 333

their importance for the investors and the general public. However, according to the authors, there are still some aspects in the functioning of the indices in the future, as changes might occur, so that the indices calculated by the BSE to increase their representativeness and to become more attractive tools for use as benchmarks in management activity

The first change is imposed by the profile described by the historical values of the indices. As it may be seen on Figure 1, joining the five indices calculated by BSE in the same graphic deprives us of any opportunity to make a comparison. This is obviously due to objective factors, as as BET, BET-C, BET-FI, BETXT and BETNG were launched from different basic data. Moreover, the BET and BET-C had worked in a period when inflation was very high and the national currency exchange rate at the time of their release was lower than the current one.

Therefore, it is required the denomination of all the BSE indices, so that on a specific reference date to have the same value for all indices. Bringing all indices at the same amount for a certain date, would open the way for a much easier tracking trends and comparison of

To achieve this denomination, an important element consists in determining *the reference date,* which should be the first day of 2007, the day that marked the accession of Romania to the European Union, and thus integration of the regulated market operated by the Bucharest

BET BET-C BET-FI BETXT BETNG

Once the indexes are denominated, it appears the following problem consisting in identifying their new *base value*. Since 2 January 2007 had already established that the reference date for two of the indices BSE - BETNG and BETXT – which were then calculated for 1000 points, a value which seems to be the most appropriate and which will greatly ease the adjustment values of Historical BET index, BET-C and BET-FI. Adjusted historical series for these three

indices of BSE will be as one that can be quite easily associated with the original series.

their indices and market sectors they represent.


**Figure 1.** BSE indices (denominated) in January 2007-8 September 2009

Stock Exchange in the unique European financial market.

portfolio.

 Assuming that the granting of a certain amount as dividend per share produces a decrease in the share price with the exact amount of the dividend, the adjustment procedure will require adding value to the price of the stock dividend is taken when calculating the indices. Otherwise, you can use an adjustment factor, multiplied by the share price is taken when calculating the index.

In the construction and management of indices there are other critical elements, which primarily aim to adapt to the concrete conditions of the stock market that they are going to describe. One such factor is the choice of a *data base*, which is preferably selected so that it does not belong to a period marked by turbulence or excessive volatility. As a general rule, the base date of an index must be chosen *"in order not to overlap with a minimum or maximum market history"*.

*The base value* of an index is also an important element in building a stock index. It should be chosen so that the reporting of the current nominal value of an index value based may allow easy calculation of percentage change in that timeframe. Therefore, the most commonly used figures based on an index value are 100 and 1,000 points.

In the case of adjusted indices, selecting a large number of shares to be part of an index basket involves assuming the possibility of relatively frequent cases of adjustment, thus reducing the transparency index. Also, a too extended composition raises serious problems for managers who use index funds as a "benchmark" or which suggest as investment strategy to make investments in securities index.

If an index is used as underlying assets for the development of financial derivatives, its composition becomes more important. It is desirable that the selected symbols, especially those with high weight in the index, have a sufficiently high level of liquidity in order not to influence the price with the idea of obtaining a more favourable settlement value of futures contracts or options. The issue of settlement value of derivatives that are underlying indexes has been addressed and in terms of prices that are taken in calculating its value at the close of trading session. Intuitively, the last price recorded in a day by a certain symbol should generate and last values of stock market index. To avoid forcing the closure of certain levels of price indexes, administrators have considered closing the option that its value is determined either as the average of past values of the index calculated based on average prices in a given period time for each symbol in its composition. This concern for the accuracy of the closing price of the shares and hence the value of stock index led some stocks to decide to introduce at the end of the trading session of the tender period in which prices are determined on a multilateral basis, through a fixing algorithm.

#### **2.3. Improvement of the management of Bucharest Stock Exchange indexes**

Through the changes that were made in time upon the methodology of calculation and management of indices, the Bucharest Stock Exchange (BSE) showed that it understands their importance for the investors and the general public. However, according to the authors, there are still some aspects in the functioning of the indices in the future, as changes might occur, so that the indices calculated by the BSE to increase their representativeness and to become more attractive tools for use as benchmarks in management activity portfolio.

332 Risk Management – Current Issues and Challenges

*market history"*.

amount of portfolio investors as a result of amounts received as dividends or the sale of preference rights indices as a result of the above events has the advantage of simplicity,

 Assuming that the granting of a certain amount as dividend per share produces a decrease in the share price with the exact amount of the dividend, the adjustment procedure will require adding value to the price of the stock dividend is taken when calculating the indices. Otherwise, you can use an adjustment factor, multiplied by the

In the construction and management of indices there are other critical elements, which primarily aim to adapt to the concrete conditions of the stock market that they are going to describe. One such factor is the choice of a *data base*, which is preferably selected so that it does not belong to a period marked by turbulence or excessive volatility. As a general rule, the base date of an index must be chosen *"in order not to overlap with a minimum or maximum* 

*The base value* of an index is also an important element in building a stock index. It should be chosen so that the reporting of the current nominal value of an index value based may allow easy calculation of percentage change in that timeframe. Therefore, the most commonly

In the case of adjusted indices, selecting a large number of shares to be part of an index basket involves assuming the possibility of relatively frequent cases of adjustment, thus reducing the transparency index. Also, a too extended composition raises serious problems for managers who use index funds as a "benchmark" or which suggest as investment

If an index is used as underlying assets for the development of financial derivatives, its composition becomes more important. It is desirable that the selected symbols, especially those with high weight in the index, have a sufficiently high level of liquidity in order not to influence the price with the idea of obtaining a more favourable settlement value of futures contracts or options. The issue of settlement value of derivatives that are underlying indexes has been addressed and in terms of prices that are taken in calculating its value at the close of trading session. Intuitively, the last price recorded in a day by a certain symbol should generate and last values of stock market index. To avoid forcing the closure of certain levels of price indexes, administrators have considered closing the option that its value is determined either as the average of past values of the index calculated based on average prices in a given period time for each symbol in its composition. This concern for the accuracy of the closing price of the shares and hence the value of stock index led some stocks to decide to introduce at the end of the trading session of the tender period in which

though in practice most indices are adjusted when there are such price changes.

share price is taken when calculating the index.

used figures based on an index value are 100 and 1,000 points.

prices are determined on a multilateral basis, through a fixing algorithm.

**2.3. Improvement of the management of Bucharest Stock Exchange indexes** 

Through the changes that were made in time upon the methodology of calculation and management of indices, the Bucharest Stock Exchange (BSE) showed that it understands

strategy to make investments in securities index.

The first change is imposed by the profile described by the historical values of the indices. As it may be seen on Figure 1, joining the five indices calculated by BSE in the same graphic deprives us of any opportunity to make a comparison. This is obviously due to objective factors, as as BET, BET-C, BET-FI, BETXT and BETNG were launched from different basic data. Moreover, the BET and BET-C had worked in a period when inflation was very high and the national currency exchange rate at the time of their release was lower than the current one.

Therefore, it is required the denomination of all the BSE indices, so that on a specific reference date to have the same value for all indices. Bringing all indices at the same amount for a certain date, would open the way for a much easier tracking trends and comparison of their indices and market sectors they represent.

**Figure 1.** BSE indices (denominated) in January 2007-8 September 2009

To achieve this denomination, an important element consists in determining *the reference date,* which should be the first day of 2007, the day that marked the accession of Romania to the European Union, and thus integration of the regulated market operated by the Bucharest Stock Exchange in the unique European financial market.

Once the indexes are denominated, it appears the following problem consisting in identifying their new *base value*. Since 2 January 2007 had already established that the reference date for two of the indices BSE - BETNG and BETXT – which were then calculated for 1000 points, a value which seems to be the most appropriate and which will greatly ease the adjustment values of Historical BET index, BET-C and BET-FI. Adjusted historical series for these three indices of BSE will be as one that can be quite easily associated with the original series.

Another problem to be solved is to develop a synthetic stock index describing the overall market share in Romania, as the Bucharest Stock Exchange also calculates a number of indices for Rasdaq: RAQ-I, RAQ-II and RASDAQ-C (which is a composite index).

Risk Management on the Romanian Capital Market 335

**BET-C:** reflects the price development of all companies listed on regulated market, Category I and Category II, except for the SIFs. BET-C is a price index weighted by market capitalization of companies in its composition. The maximum weight of a symbol in the

**BET**-**FI**: reflects the overall trend in the shares prices issued by the five financial investment companies (SIF) on the regulated market. The maximum weight of a symbol in the

**RASDAQ**-**C**: includes all the shares traded on the "RASDAQ market" and follows the

Regarding the topic, the fact that the Rasdaq-C index is calculated at the end of the trading session (and not in real time) also requires that the ALL-X index to be calculated with the

Also, the type of formula chosen is relatively simple, since all three indices (I*i*) use the arithmetic average. Therefore, the ALL-X index will use the same formula - weighted arithmetic average, as the relative importance of the three indices in the general stock market in Romania is very different, both in terms of market capitalization and liquidity of the shares in their composition. Therefore, it is necessary to use a weighted arithmetic

For the price index, the most frequent weighting factors (Pi,t) are either capitalization or liquidity. Since all of the three indexes found in the composition of ALL-X are capitalizationweighted price index, at least apparently the natural alternative is to use the same weighting criteria: capitalization. Moreover, the choice of the capitalization weighting factor ensures that the advantage of not requiring frequent rebalancing for an investor who decides to

Through its coverage, the ALL-X index will create replication difficulties. Therefore, in its construction, the focus should be on its descriptive issues and less on the investment. Consequently, it becomes important to find a variant that takes into account the weighting of liquidity, which has the disadvantage that the index can cause daily changes without evidence of membership to undergo changes, or changes in scope than the other induced increases or decreases in the BET-C index, BET-FI and Rasdaq-C. Such a compromise version could be given to the establishment of fixed predetermined weighting factors, which remain unchanged for a defined period of two consecutive data adjustment index ALL-X

In calculating these predetermined weighting factors, both the capitalization and liquidity will be taken into account. The formula for calculating the determining factors will be:

*Ui Vi Pi t* (1)

, <sup>2</sup>

adopt a passive investment strategy in relation to the ALL-X index.

BET-C composition is 20%

same frequency.

average.

(one quarter).

where:

composition of the BET-FI is 25%

synthesized global trend in prices.

One of the main concerns of a stock market operator is to identify the most effective means by which information about the activities of the regulated market that he manages, reaches the participants, from potential investors or the general public. Indexes are highly effective tools in promoting or communication, and that is why special attention should always be given to their management. Regardless of the methodology used, the scope or the "brand" adopted, the indexes must reflect as closely as the stock market developments in a given period of time, and the investors and the general public should recognize this status. Therefore, we believe that the stock market in Romania would be even discussed whether to outsource the work associated with the major indexes by a specialized international company to calculate and disseminate indexes. Market indexes license is highly specialized, with a relatively small number of participants. Therefore, "rebranding" of BSE indices under the name of one of the leading players in this market (Dow Jones, FTSE or MSCI) it would significantly increase the international exposure of local indexes.

## **2.4. Construction of a synthetic index for the stock market in Romania**

Currently, the shares of the Romanian companies are traded in two distinct market sectors (BSE - regulated market and Rasdaq), with the chance to add another market (alternative trading system). For historical, but also technical reasons, the two market sectors are currently covered by two families of indices:


Therefore, as stated, there is not a single synthetic indicator to describe the evolution of prices in the two market segments. Furthermore, in the "BET index family" there is a composite index, BET-C that does not include in its membership the five SIF symbols. So, even the most comprehensive index of the regulated market does not include the five most liquid stock market symbols, which normally accounts for almost half of the total transactions on the BSE [9].

That is why, it is necessary to create a more comprehensive stock index, which describes the overall evolution of the quotations for all shares traded on markets and market sections administered by the BSE. A possible name for this could be ALL-X, and that structure will be an "index of indices".

Once the objective is defined and the name is established, the next step is to clarify the composition of such an index, so there is no overlap, but at the same time to remain as few "areas" uncovered as well. From the analysis of the five indices of the "BET family" and all three of the "RASDAQ family" it is very clear that the optimal variant is that the composition of ALL-X to enter the next three BSE indices:

**BET-C:** reflects the price development of all companies listed on regulated market, Category I and Category II, except for the SIFs. BET-C is a price index weighted by market capitalization of companies in its composition. The maximum weight of a symbol in the BET-C composition is 20%

**BET**-**FI**: reflects the overall trend in the shares prices issued by the five financial investment companies (SIF) on the regulated market. The maximum weight of a symbol in the composition of the BET-FI is 25%

**RASDAQ**-**C**: includes all the shares traded on the "RASDAQ market" and follows the synthesized global trend in prices.

Regarding the topic, the fact that the Rasdaq-C index is calculated at the end of the trading session (and not in real time) also requires that the ALL-X index to be calculated with the same frequency.

Also, the type of formula chosen is relatively simple, since all three indices (I*i*) use the arithmetic average. Therefore, the ALL-X index will use the same formula - weighted arithmetic average, as the relative importance of the three indices in the general stock market in Romania is very different, both in terms of market capitalization and liquidity of the shares in their composition. Therefore, it is necessary to use a weighted arithmetic average.

For the price index, the most frequent weighting factors (Pi,t) are either capitalization or liquidity. Since all of the three indexes found in the composition of ALL-X are capitalizationweighted price index, at least apparently the natural alternative is to use the same weighting criteria: capitalization. Moreover, the choice of the capitalization weighting factor ensures that the advantage of not requiring frequent rebalancing for an investor who decides to adopt a passive investment strategy in relation to the ALL-X index.

Through its coverage, the ALL-X index will create replication difficulties. Therefore, in its construction, the focus should be on its descriptive issues and less on the investment. Consequently, it becomes important to find a variant that takes into account the weighting of liquidity, which has the disadvantage that the index can cause daily changes without evidence of membership to undergo changes, or changes in scope than the other induced increases or decreases in the BET-C index, BET-FI and Rasdaq-C. Such a compromise version could be given to the establishment of fixed predetermined weighting factors, which remain unchanged for a defined period of two consecutive data adjustment index ALL-X (one quarter).

In calculating these predetermined weighting factors, both the capitalization and liquidity will be taken into account. The formula for calculating the determining factors will be:

$$Pi\_{\prime}t = \frac{\mathbf{U}I\dot{\mathbf{i}} + V\dot{\mathbf{i}}}{2} \tag{1}$$

where:

334 Risk Management – Current Issues and Challenges

Another problem to be solved is to develop a synthetic stock index describing the overall market share in Romania, as the Bucharest Stock Exchange also calculates a number of

One of the main concerns of a stock market operator is to identify the most effective means by which information about the activities of the regulated market that he manages, reaches the participants, from potential investors or the general public. Indexes are highly effective tools in promoting or communication, and that is why special attention should always be given to their management. Regardless of the methodology used, the scope or the "brand" adopted, the indexes must reflect as closely as the stock market developments in a given period of time, and the investors and the general public should recognize this status. Therefore, we believe that the stock market in Romania would be even discussed whether to outsource the work associated with the major indexes by a specialized international company to calculate and disseminate indexes. Market indexes license is highly specialized, with a relatively small number of participants. Therefore, "rebranding" of BSE indices under the name of one of the leading players in this market (Dow Jones, FTSE or MSCI) it would

indices for Rasdaq: RAQ-I, RAQ-II and RASDAQ-C (which is a composite index).

significantly increase the international exposure of local indexes.

currently covered by two families of indices:

transactions on the BSE [9].

be an "index of indices".


composition of ALL-X to enter the next three BSE indices:

**2.4. Construction of a synthetic index for the stock market in Romania** 

Currently, the shares of the Romanian companies are traded in two distinct market sectors (BSE - regulated market and Rasdaq), with the chance to add another market (alternative trading system). For historical, but also technical reasons, the two market sectors are

Therefore, as stated, there is not a single synthetic indicator to describe the evolution of prices in the two market segments. Furthermore, in the "BET index family" there is a composite index, BET-C that does not include in its membership the five SIF symbols. So, even the most comprehensive index of the regulated market does not include the five most liquid stock market symbols, which normally accounts for almost half of the total

That is why, it is necessary to create a more comprehensive stock index, which describes the overall evolution of the quotations for all shares traded on markets and market sections administered by the BSE. A possible name for this could be ALL-X, and that structure will

Once the objective is defined and the name is established, the next step is to clarify the composition of such an index, so there is no overlap, but at the same time to remain as few "areas" uncovered as well. From the analysis of the five indices of the "BET family" and all three of the "RASDAQ family" it is very clear that the optimal variant is that the *Ui* is the weight that the capitalization of the symbols within Ii index holds in the total capitalization of the market, at the time of reference;

*Vi* is the weight that the value of transactions with the symbols of the Ii index holds in the total market turnover in the reference period (quarterly).

To ensure a unified form to display all BSE indices, will opt for the next version of the equivalent representation:

$$\text{(ALL-X)}\_{\text{T}} = \text{(ALL-X)}\_{\text{T-1}} \times \frac{\sum\_{i=1,N} p\_{i,T} \times I\_{i,T}}{\sum\_{i=1,N} p\_{i,T} \times I\_{i,T-1}} \tag{2}$$

Risk Management on the Romanian Capital Market 337

**Date BET-C BET-FI Rasdaq-C 23-Dec-08** 25,441,147,900 1,715,098,084 12,099,865,129 **31-Mar-09** 20,494,699,824 1,473,851,929 11,799,297,770 **30-Jun-09** 28,577,557,323 2,276,366,573 12,359,818,473 **30-Sep-09** 35,329,737,297 3,454,691,266 12,868,187,477 **24-Dec-09** 35,313,895,995 3,264,425,651 12,346,442,408 **31-Mar-10** 46,106,028,659 4,391,516,633 14,104,548,987 **30-Jun-10** 36,894,347,800 2,715,614,092 11,065,581,044 **30-Sep-10** 41,488,093,266 3,282,932,587 11,556,865,887 **30-Dec-10** 41,901,691,868 3,004,035,475 10,832,645,290


**Period BET-C BET-FI Rasdaq-C Oct - Dec 2009** 435,647,850.34 468,296,885.00 186,402,641.20 **Ian - Mar 2009** 423,175,985.74 203,780,032.70 86,885,606.44 **Apr - Jun 2009** 668,823,417.53 658,946,311.40 102,202,564.63 **Jul - Sep 2009** 600,539,594.05 728,518,117.60 94,069,608.81 **Oct - Dec 2009** 485,044,466.85 691,750,042.50 113,518,426.21 **Jan - Mar 2010** 691,952,816.70 735,425,007.50 148,602,226.21 **Apr - Jun 2010** 695,515,698.95 1,039,348,556.50 130,801,236.36 **Jul - Sep 2010** 331,670,219.85 407,212,194.50 57,407,872.87 **Oct - Dec 2010** 352,178,129.60 304,259,023.50 87,486,365.49

Based on the data presented in the previous tables, we will calculate the following elements:

**Period BET-C BET-FI Rasdaq-C Jan - Mar 2009** 64.81 hicag30.82 30.82 **Apr - Jun 2009** 60.69 4.36 34.94 **Jul - Sep 2009** 66.13 5.27 28.60 **Oct - Dec 2009** 68.40 6.69 24.91 **Jan - Mar 2010** 69.35 6.41 24.24 **Apr - Jun 2010** 71.37 6.80 21.83 **Jul - Sep 2010** 72.81 5.36 21.84 **Oct - Dec 2010** 73.65 5.83 20.52


**Table 1.** Capitalization associated to the symbols in the composition of the BSE indices

**Table 2.** Liquidity associated to the symbols in the composition of the BSE indices

**Table 3.** Weights associated to the BSE indices in total capitalization (*%*)

Quarter IV 2010 (RON).

where:

*Pt,i:* weighting factor at time T, associated with each index in the composition of ALL-X; *Ii,t:* ALL-X indices, at time T (BET-C, BET-FI, Rasdaq-C).

To ensure the possibility to compare the new ALL-X index with the main stock market index, BET, the start value will be 2901.10 points and the start date will be fixed for 31.12.2008. The calculation of the weighting factor, Pi,t, will be done quarterly, on the last trading day of the final month of the quarter, and will enter into force on the first trading session of the next quarter [10].

The main advantage of building the index ALL-X is that it can be obtained a simple and effective tool to provide an overview of the entire stock market development in Romania. The index is limited to the evolution of shares issued by the Romanian companies, while any direct influence induced by the prices movement of foreign securities admitted to trading on domestic capital market was being removed from the beginning.

In the presented form, ALL-X index is defined primarily as a descriptive index and less like an investment. This deficiency can be corrected later, to the extent that the BSE will decide to use the same calculation methodology for all its indices, regardless of the section or market segment that is addressed: regulated market, Rasdaq market or alternative trading system. Moreover, in order to emphasize the character of investment, it will be necessary to modify the weighting factor (which may become the capitalization of each index), as well as the dates when its new value is calculated and effective.

To calculate the ALL-X index values retrospectively, after the release date was determined (December 31, 2008) and the reference value at that time (2901.10 points), the first step is to determine the Ui and Vi factors for the first quarterly interval (January-March 2009). To this end it will determine:



**Table 1.** Capitalization associated to the symbols in the composition of the BSE indices

336 Risk Management – Current Issues and Challenges

equivalent representation:

session of the next quarter [10].

end it will determine:

2010 (RON);

where:

capitalization of the market, at the time of reference;

total market turnover in the reference period (quarterly).

*Ii,t:* ALL-X indices, at time T (BET-C, BET-FI, Rasdaq-C).

dates when its new value is calculated and effective.

*Ui* is the weight that the capitalization of the symbols within Ii index holds in the total

*Vi* is the weight that the value of transactions with the symbols of the Ii index holds in the

To ensure a unified form to display all BSE indices, will opt for the next version of the

T T-1

*Pt,i:* weighting factor at time T, associated with each index in the composition of ALL-X;

To ensure the possibility to compare the new ALL-X index with the main stock market index, BET, the start value will be 2901.10 points and the start date will be fixed for 31.12.2008. The calculation of the weighting factor, Pi,t, will be done quarterly, on the last trading day of the final month of the quarter, and will enter into force on the first trading

The main advantage of building the index ALL-X is that it can be obtained a simple and effective tool to provide an overview of the entire stock market development in Romania. The index is limited to the evolution of shares issued by the Romanian companies, while any direct influence induced by the prices movement of foreign securities admitted to

In the presented form, ALL-X index is defined primarily as a descriptive index and less like an investment. This deficiency can be corrected later, to the extent that the BSE will decide to use the same calculation methodology for all its indices, regardless of the section or market segment that is addressed: regulated market, Rasdaq market or alternative trading system. Moreover, in order to emphasize the character of investment, it will be necessary to modify the weighting factor (which may become the capitalization of each index), as well as the

To calculate the ALL-X index values retrospectively, after the release date was determined (December 31, 2008) and the reference value at that time (2901.10 points), the first step is to determine the Ui and Vi factors for the first quarterly interval (January-March 2009). To this


trading on domestic capital market was being removed from the beginning.

(ALL-X) (ALL-X)

, ,

*p I*

*iT iT*

, , 1

(2)

*iT iT*

*p I*

1,

*i N*

1,

*i N*

*x*



**Table 2.** Liquidity associated to the symbols in the composition of the BSE indices

Based on the data presented in the previous tables, we will calculate the following elements:



**Table 3.** Weights associated to the BSE indices in total capitalization (*%*)


Risk Management on the Romanian Capital Market 339

The biggest weight in the ALL-X index is given by the BET-C composite index. The values of Pi,t associated with the BET-C for the full period 2009-2010 ranged between 0.5 and 0.6

Stock markets investors constantly face several risks, which is why researchers have focused their concerns on issues related to developing risk management improved models of assessment and management. Among the latest methods used in economic practice in

Risk Grades indicator provides a synthetic image of the risk associated with a certain financial security, a portfolio or an index. This new way of measuring volatility is based on exactly the same data and analysis as VaR, while making it possible to translate the Risk Grades estimates in terms of VaR. Furthermore, Risk Grades methodology is intended to be

Allows comparison between different investment classes, regions and different areas, is

( ) 100 *<sup>i</sup> i*

*RiskGrades x*

*base*

(3)

assessing risk in financial markets the method *Value at Risc (VaR)* is required [11].

more intuitive and easier to use than VaR. The characteristics of the Risk Grades are:

It is a dynamic method of measurement that adjusts to the market conditions

a standardized method of measuring volatility Allows comparison of different market indices.

The Risk Grades formula for the financial asset *i* is:

where: σi the volatility of the financial asset *"i"*  σbase the base volatility

**Figure 3.** Evolution of DJIA between 1 Jan 2006 – 30 Dec. 2010

percent.

**2.5. Risk assessment indices** 


**Table 4.** Weights associated to the BSE indices in total liquidity (*%*)

Once the weights are determined, it will be necessary to calculate the weighting factors in the composition of each ALL-X index for each quarter:


**Table 5.** Weighting factors Pi,t

**Figure 2.** Evolution of the ALL-X index vs. Evolution of BET index (Jan. 2009 – Dec. 2010)

The biggest weight in the ALL-X index is given by the BET-C composite index. The values of Pi,t associated with the BET-C for the full period 2009-2010 ranged between 0.5 and 0.6 percent.

## **2.5. Risk assessment indices**

338 Risk Management – Current Issues and Challenges


**Table 4.** Weights associated to the BSE indices in total liquidity (*%*)

the composition of each ALL-X index for each quarter:

**Table 5.** Weighting factors Pi,t

**Period BET-C BET-FI Rasdaq-C Ian - Mar 2009** 39.95 42.95 17.10 **Apr - Jun 2009** 59.28 28.55 12.17 **Jul - Sep 2009** 46.77 46.08 7.15 **Oct - Dec 2009** 42.20 51.19 6.61 **Jan - Mar 2010** 37.59 53.61 8.80 **Apr - Jun 2010** 37.28 55.71 7.01 **Jul - Sep 2010** 41.65 51.14 7.21 **Oct - Dec 2010** 47.34 40.90 11.76

Once the weights are determined, it will be necessary to calculate the weighting factors in

**Period BET-C BET-FI Rasdaq-C** 

**Figure 2.** Evolution of the ALL-X index vs. Evolution of BET index (Jan. 2009 – Dec. 2010)

 Ui Vi **Pi** Ui Vi **Pi** Ui Vi **Pi Ian - Mar 2009** 0.6481 0.3995 **0.5238** 0.0437 0.4295 **0.2366** 0.3082 0.1710 **0.2396 Apr - Jun 2009** 0.6069 0.5928 **0.5999** 0.0436 0.2855 **0.1646** 0.3494 0.1217 **0.2356 Jul - Sep 2009** 0.6613 0.4677 **0.5645** 0.0527 0.4608 **0.2567** 0.2860 0.0715 **0.1787 Oct - Dec 2009** 0.6840 0.4220 **0.5530** 0.0669 0.5119 **0.2894** 0.2491 0.0661 **0.1576 Ian - Mar 2010** 0.6935 0.3759 **0.5347** 0.0641 0.5361 **0.3001** 0.2424 0.0880 **0.1652 Apr - Jun 2010** 0.7137 0.4391 **0.5764** 0.0680 0.4666 **0.2673** 0.2183 0.0943 **0.1563 Jul - Sep 2010** 0.7281 0.3728 **0.5504** 0.0536 0.5571 **0.3053** 0.2184 0.0701 **0.1442 Oct - Dec 2010** 0.7365 0.4165 **0.5765** 0.0583 0.5114 **0.2848** 0.2052 0.0721 **0.1386**  Stock markets investors constantly face several risks, which is why researchers have focused their concerns on issues related to developing risk management improved models of assessment and management. Among the latest methods used in economic practice in assessing risk in financial markets the method *Value at Risc (VaR)* is required [11].

Risk Grades indicator provides a synthetic image of the risk associated with a certain financial security, a portfolio or an index. This new way of measuring volatility is based on exactly the same data and analysis as VaR, while making it possible to translate the Risk Grades estimates in terms of VaR. Furthermore, Risk Grades methodology is intended to be more intuitive and easier to use than VaR. The characteristics of the Risk Grades are:


The Risk Grades formula for the financial asset *i* is:

$$RiskGrade\_{(i)} = \frac{\sigma\_i}{\sigma\_{base}} \ge 100\tag{3}$$

where: σi the volatility of the financial asset *"i"*  σbase the base volatility

**Figure 3.** Evolution of DJIA between 1 Jan 2006 – 30 Dec. 2010

To determine the Risk Grades values associated to the main indices calculated by the BSE (BET, BET-FI, BET-C) it will be considered a decay factor λ = 0.98, which corresponds to a minimum number of records n = ln (0.1)/ln (λ) of 113. The series of values for indexes is 1 January 2008 to 30 December 2010 and the index used as reference for determining the Dow Jones Industrial Average (DJIA) is σbase.

Risk Management on the Romanian Capital Market 341

and limits the maximum weight of one symbol included in the WIG20 to 15%. Currently, the most important companies included in the WIG20 index are PKO BP, KGHM, DAM and

The **PX Index** is an index of major stocks that trade on the Prague Stock Exchange. The 5th of April 1994 was selected as the starting exchange day (a benchmark date) for the Index PX 50 and its opening value was fixed at 1,000 points. At this time the index included 50 companies traded on the Prague Stock Exchange, accordingly named PX 50. In 20 March 2006 the PX 50 index was merged with PX-D into the PX index, having now 14 symbols of the Prague stock market in its composition. The maximum weight for a stock symbol included in PX was set to 20% and from the companies included in the PX index the most

**Figure 5.** Risk Grades values for the main indexes in the region between 21 May 2009 - 30 Dec.2010

**3. Risk management in settlement of stock transactions** 

depositories are not less important, but are maybe less visible to the public.

**3.1. Clearing and settlement of stock market transactions** 

PX index, the difference is very small [12].


50

100

150

200

250

300

When comparing the Risk Grades values of WIG20 index of the Warsaw Stock Exchange and of PX index of the Prague Stock Exchange with those of the Romanian Stock Exchange (see figure 5), we reach a surprisingly conclusion, that the Risk Grades values calculated for the main indexes in the Central and Eastern Europe do not show major differences. Although constantly the Risk Grades values are above those associated with the WIG20 and

WIG20 BET

The risks managed by Institutions such as market operators, clearing houses and central

It is known that stock market transactions are followed by a mutual transfer of ownership from seller to buyer, and the amount of money equivalent, from buyer to seller. Clearing

important are CEZ, Comercni Banka, Erste Group Bank and Telefonika.

Bank Pekao.

We can notice in the above chart the negative effects of the financial crisis that occurred on the DJIA mainly by early 2009, when the North American stock market indexes registered multi-minimum (on 9 March 2009, the DJIA was calculated for 6547 points). Choosing the interval 1 January 2009 to 30 Dec.2010 for the series of values Risk Grades indices used in the calculation took into account to cover both a pronounced downward trend of the DJIA index and an increasing trend after March 9 2009.

**Figure 4.** Risk Grades values for BSE indexes between 21 May 2009 - 30 Dec.2010

The Risk Grades values determined for the BSE indexes confirms that the Romanian capital market is riskier than the North American capital market. Besides that, as one can notice from the above chart, the Risk Grades values of the ALL-X index are consistently positioned below the BET-FI sector index and above the associated BET and BET-C.

If decay factor λ = 0,96 was chosen, the minimum number of records that we need is 228, sufficient for our purpose, consisting in comparing the risk associated with the capital market in Romania with those determined for other international stock markets or within the region.

In order to make a comparative analysis of the risks on the Romanian capital market and the main indexes of the Central and Eastern Europe we took into consideration the main indexes of Poland and the Czech Republic capital markets, meaning the WIG20 and the PX.

The **WIG20** index is the underlying instrument for futures transactions listed on the Warsaw Stock Exchange and represents a modified capitalization-weighted index of 20 Polish stocks which are listed on the main market. The base value was set to 1000 points in April 16th 1994. The WIG20 index may not include more than 5 companies from a single exchange sector and limits the maximum weight of one symbol included in the WIG20 to 15%. Currently, the most important companies included in the WIG20 index are PKO BP, KGHM, DAM and Bank Pekao.

340 Risk Management – Current Issues and Challenges

Jones Industrial Average (DJIA) is σbase.

the region.

index and an increasing trend after March 9 2009.

**Figure 4.** Risk Grades values for BSE indexes between 21 May 2009 - 30 Dec.2010

below the BET-FI sector index and above the associated BET and BET-C.

The Risk Grades values determined for the BSE indexes confirms that the Romanian capital market is riskier than the North American capital market. Besides that, as one can notice from the above chart, the Risk Grades values of the ALL-X index are consistently positioned

ALL-X BET BET-C BETFI

If decay factor λ = 0,96 was chosen, the minimum number of records that we need is 228, sufficient for our purpose, consisting in comparing the risk associated with the capital market in Romania with those determined for other international stock markets or within

In order to make a comparative analysis of the risks on the Romanian capital market and the main indexes of the Central and Eastern Europe we took into consideration the main indexes of Poland and the Czech Republic capital markets, meaning the WIG20 and the PX. The **WIG20** index is the underlying instrument for futures transactions listed on the Warsaw Stock Exchange and represents a modified capitalization-weighted index of 20 Polish stocks which are listed on the main market. The base value was set to 1000 points in April 16th 1994. The WIG20 index may not include more than 5 companies from a single exchange sector

To determine the Risk Grades values associated to the main indices calculated by the BSE (BET, BET-FI, BET-C) it will be considered a decay factor λ = 0.98, which corresponds to a minimum number of records n = ln (0.1)/ln (λ) of 113. The series of values for indexes is 1 January 2008 to 30 December 2010 and the index used as reference for determining the Dow

We can notice in the above chart the negative effects of the financial crisis that occurred on the DJIA mainly by early 2009, when the North American stock market indexes registered multi-minimum (on 9 March 2009, the DJIA was calculated for 6547 points). Choosing the interval 1 January 2009 to 30 Dec.2010 for the series of values Risk Grades indices used in the calculation took into account to cover both a pronounced downward trend of the DJIA The **PX Index** is an index of major stocks that trade on the Prague Stock Exchange. The 5th of April 1994 was selected as the starting exchange day (a benchmark date) for the Index PX 50 and its opening value was fixed at 1,000 points. At this time the index included 50 companies traded on the Prague Stock Exchange, accordingly named PX 50. In 20 March 2006 the PX 50 index was merged with PX-D into the PX index, having now 14 symbols of the Prague stock market in its composition. The maximum weight for a stock symbol included in PX was set to 20% and from the companies included in the PX index the most important are CEZ, Comercni Banka, Erste Group Bank and Telefonika.

**Figure 5.** Risk Grades values for the main indexes in the region between 21 May 2009 - 30 Dec.2010

When comparing the Risk Grades values of WIG20 index of the Warsaw Stock Exchange and of PX index of the Prague Stock Exchange with those of the Romanian Stock Exchange (see figure 5), we reach a surprisingly conclusion, that the Risk Grades values calculated for the main indexes in the Central and Eastern Europe do not show major differences. Although constantly the Risk Grades values are above those associated with the WIG20 and PX index, the difference is very small [12].
