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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India’s Largest Analytics Forum
Market Risk
Vineet Khanna
Practice Head - BFSI
SAS 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 Reporting
Copyright © 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
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4. Risk Factors & Models
Risk Factors
• Granularity
Modelling
• Relevance
• Fitting
• Validation
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5. Market Risk Measures
Aggregate and Sub-
portfolio
Incremental & Marginal
Factor Sensitivities
Risk Factor contributions
Hedge effectiveness
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6. Stress Testing
Rigorous & Routine
Range of factors
Qualitative & quantitative
Periods of financial stress
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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 truncation
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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
Loss
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9. Basel III Era
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10. Implementation of Basel III Regulation in India
Source – RBI Website
10
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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
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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 Exposure
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13. Advanced models
Estimation and simulation of risk models
Configuring pricing behavior
Exposure and netting
Collateral
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14. PFE Calculation
Expected Exposure (EE)
Expected Positive Exposure (EPE)
Effective EPE
PFE
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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)
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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)
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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 CDS
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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, etc
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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 >>>
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India’s Largest Analytics Forum
Thank You
Vineet.khanna@sas.com (Vineet Khanna)
Copyright © 2010, SAS Institute Inc. All rights reserved.