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Market Risk

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Given the recent financial crisis and the extended impact on global credit market and liquidity, it is imperative that financial institutions strengthen their market risk management capabilities to …

Given the recent financial crisis and the extended impact on global credit market and liquidity, it is imperative that financial institutions strengthen their market risk management capabilities to effectively meet compelling business objectives and challenges which include portfolio pricing and portfolio exposure management

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  • 1. make connections • share ideas • be inspired India’s Largest Analytics ForumMarket RiskVineet KhannaPractice Head - BFSISAS Institute (India) Pvt. Ltd Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 2. Agenda Market Risk – Key Considerations Basel III – Credit Counterparty Exposure Management • Exposure Calculation • PFE • Collateral & CSA • CVA ReportingCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 3. Market Risk – Key Considerations • Risk Factors• Data Governance • Valuation• Data Integrity • VaR Calculation• Models Audit & Transparency Analysis & Measures • Back Testing• Processes • Stress Testing• Documentation Basel II • Incremental Risk Charge • Current Exposure Method Reporting & Credit & • STD, IMM Limit Counterparty Monitoring Exposure • Capital Calculation Management • ICAAP • Use Test & Experience Test Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 4. Risk Factors & Models Risk Factors • Granularity Modelling • Relevance • Fitting • ValidationCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 5. Market Risk Measures Aggregate and Sub- portfolio Incremental & Marginal Factor Sensitivities Risk Factor contributions Hedge effectivenessCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 6. Stress Testing Rigorous & Routine Range of factors Qualitative & quantitative Periods of financial stressCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 7. Model Backtesting Unconditional Coverage Test Interval Test Conditional Coverage Test Duration based tests • Use Weibull distribution to test unconditional, conditional coverage and independence • Efficiency treatment for small samples − Monte-Carlo p-values and truncationCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 8. Incremental Risk Charge Default & Migrating Risk 1 year Horizon, 99.9% Confidence level Explicitly consider liquidity horizon AAA Bond AAA Bond AAA Bond AAA Bond A Bond BB Bond AA Bond B Bond 3 Months 6 Months 9 Months 12 Months Loss= Value AAA Bond – Loss= Value AAA Bond – Loss= Value AAA Bond – Loss= Value AAA Bond – Value A Bond Value BB Bond Value AA Bond Value B Bond Total Aggregated LossCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 9. Basel III EraCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 10. Implementation of Basel III Regulation in India Source – RBI Website 10Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 11. WHAT ARE THE RISK PRIORITIES FOR FS? In which of the following areas do you think the most significant focus should be to address current shortcomings in risk management? Select up to three. EIU/SAS- ERM “Rebuilding Trust” Research & Briefing took place February to March 2010 Survey of 346 financial services executives 50% C level – all have responsibility for risk Even global distribution Programme of in-depth interviews with high-level experts Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 12. Calculation of CCR exposure Basel II • Current Exposure Method (CEM) − Replacement cost + add-on − Regulatory or internal add-ons • Standardized Method (STD) − Portfolio market value – Collateral market value − Risk positions (can be calculated or supplied) and hedging sets • Internal Model Method (IMM) − EPE x Alpha Potential Future ExposureCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 13. Advanced models Estimation and simulation of risk models Configuring pricing behavior Exposure and netting CollateralCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 14. PFE Calculation Expected Exposure (EE) Expected Positive Exposure (EPE) Effective EPE PFECopyright © 2011, SAS Institute Inc. All rights reserved.
  • 15. Collateral Collateral and CSA contracts • Method of allocation to specify the structure of the CSA and other security contracts − Independent Amt, Threshold, Min Transfer etc • Can have multiple exposures (nettingset) in several agreements • Collateral can also be modelled (with correlation to positions)Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 16. Basel III calculation of exposures – Wrong-way risk General wrong-way risk • Estimate risk models on data with high volatility 2008-2009 • The same period as the internal market risk models for new stressed capital component of market risk Specific wrong-way risk • Use explicit price models with wrong- way risk Option (vulnerable options) − Johnson and Stulz (1987) • CDS counterparty risk − Hull and White (2001)Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 17. CVA reporting Basel III reporting of CVA capital • Use the standard market risk calculation – P/L power • The same model as the current model of idiosyncratic spread risk • Replace spreads in the model with the CDS premiums if exists • Exposure per counterparty is EAD CVA Capital = 99.9% VaR Single risk component is CDSCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 18. Calculations Update of all exposures • Billion Revaluation adjustments, as well as guarantees and netting Updating of exposure to specific counterparty for pre- deal CVA • Millions of revaluations and guarantees and netting What needs to be calculated and how. It is sufficient approximation or full exposure estimate with simulation Trading desk Risk system CVA desk Trading desk Exposures, etcCopyright © 2011, SAS Institute Inc. All rights reserved.
  • 19. Market Risk for Banking Executive Risk Portal Add-in for MS Office Other SAS Clients Risk Reporting Data Model SAS Risk Clients: Business User Flex UI and Analytical Risk User Java Client Application Common: Reconciliation, Portfolio Segmentation, Backtesting Market Risk Credit Risk ALM Firm-wide Risk Cash Flow Analysis, FTP Mark to Market Portfolio Credit Risk Risk Aggregation and Liquidity Risk Scenario Analysis, Counterparty Exposure Cash Flow Optimization Firmwide Risk Analysis Risk (VaR) Calculation Firmwide Portfolio Market Portfolio Optimization Credit Portfolio Optimization Economic Value Calculation Optimization Common Risk Foundation: Pricing Models, Cash Flow Models and Methods Data Management – Data Models and Data Flows – DDS and Data Marts Trading Systems ERP Systems Other Risk Systems >>>Copyright © 2011, SAS Institute Inc. All rights reserved.
  • 20. make connections • share ideas • be inspiredIndia’s Largest Analytics ForumThank YouVineet.khanna@sas.com (Vineet Khanna) Copyright © 2010, SAS Institute Inc. All rights reserved.