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We studied the CBOE Market Volatility Index
from 1995 to 2004 and the Cross-Sectional Volatility of MSCI US and MSCI AC
Asia ex Japan of the same period. Tracking Error calculations and Market
Volatility Analyses were performed. We selected a portfolio, Dragon, for Risk
Analysis, Risk Decomposition and Risk Characteristics identification purposes.
A conclusion relating Dragon’s Tracking Error and its Portfolio Size was drawn.
Background: While working as risk
consultants at Barra in 1990’s, the first two authors decided to start
collaborating on a research project with its first paper titled “Application of
Volatility in Portfolio Construction” . The third author was then a risk
manager of a financial institution which was a client of Barra’s. Bringing his
expertise in portfolio risk management, he joined the research team. Aim: The
core of this paper lies in the construction of an investment portfolio with a
main objective of value appreciation while examining its tracking error -,
a risk measurement with reference to a benchmark  . The authors believe, while
tracking error measurement is a common tool for portfolio risk management, total
risk measurement is more important. The management goal is to minimize
drawbacks using the technique of risk budgeting. These topics will be discussed
in future research papers.