Measuring potential market risk

We argue herein that there is a fundamental and an important difference between the market risk and the potential market risk in financial markets. We also argue that the spectrum of smooth Lyapunov exponents can be used in (lambda,sigma(2))-analysis, which is a method to measure and monitor these risks. The reason is that these exponents focus on the stability properties (lambda) of the stochastic dynamic system generating asset returns, while more traditional risk measures such as value-at-risk are concerned with the distribution of asset returns (sigma(2)). (C) 2009 Elsevier B.V. All rights reserved.