Throughout this presentation, you’ll learn:
General risks faced by banking institutions on the derivatives markets.
How the main banking/accounting regulatory bodies’ actions are framing the banking industry (SA-CCR, IFRS 13, etc.).
The origins of xVAs and how they are challenging the so-far asset valuation theory.
The quantification techniques of CVA components.
The existing CVA risk mitigation techniques.
This document discusses various risk management tools in Treasury and Risk Management including net present value, value-at-risk, gap analysis, and asset liability management. It provides an overview of different risk measurement approaches and how they are used to analyze market, credit, liquidity, and other banking risks. The presentation also outlines how simulated transactions can be generated and evaluated within SAP functions for applications like stress testing, sensitivity analysis, and interest rate risk modeling.
Counterparty Credit Risk and CVA under Basel IIIHäner Consulting
Financial institutions which apply for an IMM waiver under Basel III need to fullfill a broad set of requirements. We present the quantitative, organizational and operational implications and provide some hand-on guidance how to fulfill the regulatory requirements.
Asset Liability Management (ALM) is concerned with strategic balance sheet management involving risks caused by changes in interest rates, exchange rates, and liquidity position. ALM aims to match assets and liabilities in terms of maturities and interest rate sensitivities to minimize interest rate risk and liquidity risk. It involves identifying, measuring, monitoring, and controlling risks like interest rate risk, liquidity risk, credit risk, and contingency risk through techniques like gap analysis and duration gap analysis. Effective ALM requires strong organizational framework, information systems, and regular monitoring and reporting to manage risks.
1. The document discusses asset and liability management (ALM) in commercial banks, including the objectives, characteristics, and evolution of ALM systems.
2. It describes the components of an ALM system architecture including modeling, reporting, and decision making processes to manage interest rate risk and liquidity risk.
3. Key aspects of ALM covered include earnings and economic value perspectives, interest rate risk measurement, term structure modeling, and liquidity risk management.
1) Asset-liability management (ALM) is the process of managing a bank's assets and liabilities to minimize risk from interest rates and liquidity.
2) ALM involves measuring and managing risks like liquidity risk, interest rate risk, and currency risk to protect a bank's net interest margin.
3) The key objectives of ALM are liquidity risk management, interest rate risk management, currency risk management, and profit planning.
The document provides an overview of key changes under the Fundamental Review of the Trading Book (FRTB). Some key points include:
- Internal model approvals will be done at a more granular trading desk level rather than bank level. Desks will also face new profit and loss attribution tests.
- Value-at-Risk and Stressed Value-at-Risk will be replaced by Expected Shortfall as the single risk measure for internal models. Expected Shortfall will be based on a 1-year stress period.
- Liquidity risk will be defined at the risk factor level rather than position level. Standardized liquidity horizons of 10, 20, 40, 60, 120 days will be
Augusto carvalho gestión de riesgo de crédito en portafolio - final edition...Augusto_Carvalho
El 19 Congreso de Tesorería, incluye los temas más relevantes para la gestión de Tesorería y para la acertada toma de decisiones del día a día en los mercados financieros, por ejemplo: Evolución de la economía global y local, las tendencias mundiales en gestión de tesorería corporativa para el sector real, los retos y las oportunidades para el mercado de deuda pública, así como la gestión de liquidez y riesgo de crédito bajo los lineamientos de Basilea III.
The effect of VaR-based risk management on asset prices and the volatility s...Nicha Tatsaneeyapan
This document summarizes a research paper that investigates the effects of Value-at-Risk (VaR) based risk management on asset prices and option prices. The key points are:
1) The authors build an economic model to study how VaR constraints affect stock and option markets. They find that VaR constraints generally reduce stock market volatility but can sometimes increase risks of extreme losses.
2) Option prices in the model display a "volatility smile" where implied volatilities are higher for out of the money options, consistent with real world markets.
3) VaR constraints are similar to the optimal investment strategies of loss-averse investors, who try to limit losses but take risks once losses
This document discusses various risk management tools in Treasury and Risk Management including net present value, value-at-risk, gap analysis, and asset liability management. It provides an overview of different risk measurement approaches and how they are used to analyze market, credit, liquidity, and other banking risks. The presentation also outlines how simulated transactions can be generated and evaluated within SAP functions for applications like stress testing, sensitivity analysis, and interest rate risk modeling.
Counterparty Credit Risk and CVA under Basel IIIHäner Consulting
Financial institutions which apply for an IMM waiver under Basel III need to fullfill a broad set of requirements. We present the quantitative, organizational and operational implications and provide some hand-on guidance how to fulfill the regulatory requirements.
Asset Liability Management (ALM) is concerned with strategic balance sheet management involving risks caused by changes in interest rates, exchange rates, and liquidity position. ALM aims to match assets and liabilities in terms of maturities and interest rate sensitivities to minimize interest rate risk and liquidity risk. It involves identifying, measuring, monitoring, and controlling risks like interest rate risk, liquidity risk, credit risk, and contingency risk through techniques like gap analysis and duration gap analysis. Effective ALM requires strong organizational framework, information systems, and regular monitoring and reporting to manage risks.
1. The document discusses asset and liability management (ALM) in commercial banks, including the objectives, characteristics, and evolution of ALM systems.
2. It describes the components of an ALM system architecture including modeling, reporting, and decision making processes to manage interest rate risk and liquidity risk.
3. Key aspects of ALM covered include earnings and economic value perspectives, interest rate risk measurement, term structure modeling, and liquidity risk management.
1) Asset-liability management (ALM) is the process of managing a bank's assets and liabilities to minimize risk from interest rates and liquidity.
2) ALM involves measuring and managing risks like liquidity risk, interest rate risk, and currency risk to protect a bank's net interest margin.
3) The key objectives of ALM are liquidity risk management, interest rate risk management, currency risk management, and profit planning.
The document provides an overview of key changes under the Fundamental Review of the Trading Book (FRTB). Some key points include:
- Internal model approvals will be done at a more granular trading desk level rather than bank level. Desks will also face new profit and loss attribution tests.
- Value-at-Risk and Stressed Value-at-Risk will be replaced by Expected Shortfall as the single risk measure for internal models. Expected Shortfall will be based on a 1-year stress period.
- Liquidity risk will be defined at the risk factor level rather than position level. Standardized liquidity horizons of 10, 20, 40, 60, 120 days will be
Augusto carvalho gestión de riesgo de crédito en portafolio - final edition...Augusto_Carvalho
El 19 Congreso de Tesorería, incluye los temas más relevantes para la gestión de Tesorería y para la acertada toma de decisiones del día a día en los mercados financieros, por ejemplo: Evolución de la economía global y local, las tendencias mundiales en gestión de tesorería corporativa para el sector real, los retos y las oportunidades para el mercado de deuda pública, así como la gestión de liquidez y riesgo de crédito bajo los lineamientos de Basilea III.
The effect of VaR-based risk management on asset prices and the volatility s...Nicha Tatsaneeyapan
This document summarizes a research paper that investigates the effects of Value-at-Risk (VaR) based risk management on asset prices and option prices. The key points are:
1) The authors build an economic model to study how VaR constraints affect stock and option markets. They find that VaR constraints generally reduce stock market volatility but can sometimes increase risks of extreme losses.
2) Option prices in the model display a "volatility smile" where implied volatilities are higher for out of the money options, consistent with real world markets.
3) VaR constraints are similar to the optimal investment strategies of loss-averse investors, who try to limit losses but take risks once losses
CAPM was developed in 1960 as an extension of Markowitz's portfolio theory. It derives the relationship between expected return and risk of individual securities. CAPM assumes investment decisions are based on risk-return assessments and that markets are efficient. It allows investors to combine risky and risk-free assets on the efficient frontier to maximize return for a given level of risk. The model is used to price individual securities based on their beta and expected market return.
Capital Asset Pricing Model (CAPM) was introduced in 1964 as an extension of the Modern Portfolio Theory which seeks to explore the diverse ways by which investors can construct investment portfolios through means that can possibly minimize risk levels and at the same time ensure maximization of returns.
Chapter 13 basel iv market risk frameworkQuan Risk
The document summarizes the Basel IV framework for managing market risk. It introduces the four pillars of Basel IV - minimum capital requirements, supervisory review, public disclosure, and liquidity sufficiency. It then discusses the regulatory approaches to calculating market risk capital charges, including the internal models approach and standardized approach. The internal models approach uses an expected shortfall model and requires significant regulatory approval. The standardized approach uses a variance-covariance method and is simpler but less risk sensitive.
Stress testing involves simulating the impact of exceptional but plausible risk factor changes on a bank's financial position. BASIC Bank uses stress testing techniques to quantify the effects of changes in credit, interest rate, exchange rate, equity price, liquidity, and other risks. Scenarios are developed to assess the bank's resilience under various adverse conditions, such as increases in non-performing loans, falls in collateral values, or defaults by major borrowers.
Measuring risk essentials of financial risk managementChho Phet
The document discusses various methods of measuring financial risk. It covers measures of exposure like risk exposure calculations, gap analysis, and stress testing. It then discusses value-at-risk (VaR) as a common measure of market risk, how it estimates potential portfolio losses based on historical data, and how it can be calculated using variance-covariance models or historical simulation. Monte Carlo simulation is also mentioned as another technique for calculating VaR.
Regulatory reporting of market risk under the basel iv frameworkQuan Risk
This document provides an overview of regulatory market risk capital requirements under the Basel IV framework. It discusses the expected shortfall approach and standardized variance-covariance method for calculating market risk capital charges. The internal model approach uses an bank's expected shortfall model and is more risk sensitive but also more complex and stringent. The standardized approach applies standardized calculations and correlation coefficients specified in Basel IV and is simpler but less risk sensitive.
Risk, Return, & the Capital Asset Pricing ModelHarish Manchala
This document discusses risk and return concepts including stand-alone risk, market risk, diversification, and the capital asset pricing model (CAPM). It defines key terms like beta, expected return, standard deviation, and the security market line. The document also provides examples of calculating beta for an individual stock and using the CAPM to determine the required return for different investments based on their level of market risk.
Regulatory reporting of market risk underthe Basel III frameworkQuan Risk
This document provides an overview of regulatory reporting requirements for market risk. It discusses the internal model method and standardized method for calculating market risk capital charges (MRCC) according to Basel III rules. The internal model method uses value-at-risk (VaR) models to calculate charges and requires regulatory approval. The standardized method applies fixed capital ratios to positions to calculate charges and has less risk sensitivity but also less regulatory requirements.
1) Asset/liability management (ALM) is the process of making decisions about the composition of a bank's assets and liabilities in order to manage risks and ensure sustainable profits.
2) ALM decisions are typically made by a bank's asset/liability management committee (ALCO) and involve strategic balance sheet management to match assets and liabilities.
3) The goal of ALM is to manage sources and uses of funds with respect to interest rate risk and liquidity risk arising from mismatches between assets and liabilities.
This document discusses risk and the Capital Asset Pricing Model (CAPM). It defines CAPM as a framework for determining expected returns based on systematic risk. CAPM shows that the expected return of an asset is determined by its beta, a measure of non-diversifiable risk relative to the market. The document outlines the key elements of CAPM including the capital market line, security market line, systematic and unsystematic risk, beta, and the CAPM formula. It also lists the assumptions of CAPM and provides explanations of systematic and unsystematic risk.
The chapter discusses the Capital Asset Pricing Model (CAPM). It introduces the efficient frontier and capital market line. The CAPM hypothesizes that the expected return of an asset is determined by its sensitivity to non-diversifiable risk, as represented by beta. All rational investors will hold the market portfolio and use leverage/borrowing according to their risk tolerance. The CAPM is used to determine the required rate of return for assets and their cost of equity.
Capital Asset Pricing Model, CAPM Assumptions, Borrowing and Lending Possibilities, Risk-Free Lending, Borrowing Possibilities, The New Efficient Set, Portfolio Choice, Market Portfolio, Characteristics of the Market Portfolio, Capital Market Line, The Separation Theorem, Security Market Line, CAPM’s Expected Return-Beta Relationship, How Accurate Are Beta Estimates?,
Capital Asset Pricing Model (CAPM)
A model that describes the relationship between risk and expected return. The general idea behind CAPM is that investors need to be compensated in two ways: time value of money & risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk gauge (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).
Operational Risk Loss Forecasting Model for Stress TestingCRISIL Limited
Presentation on ‘Operational Risk Loss Forecasting Model for Stress Testing – A Three-Stage Approach’ made by Dr. James Lu, Director, Risk & Analytics, CRISIL Global Research & Analytics (GR&A) at The 17th Annual OpRisk North America 2015, New York
This document provides an overview of asset-liability management (ALM) systems for banks and financial institutions. It discusses why ALM is important due to factors like globalization, deregulation, and integration of markets. The key objectives of ALM are to manage liquidity risk, interest rate risk, currency risk, and to aid in profit planning and growth projections. Specific risks like credit, market and operational risks are also discussed. The document outlines the ALM process, including generating statements to measure liquidity mismatches and interest rate sensitivity over different time periods. Tools for analyzing liquidity and interest rate risk are also presented. Overall organizational structure for effective ALM implementation is emphasized.
The document discusses the Capital Asset Pricing Model (CAPM). It explains that CAPM provides a framework to determine the required rate of return on an asset based on its relationship to risk. It also discusses the model's assumptions and how beta is used to measure non-diversifiable risk. Further, it shows how CAPM is used to estimate the cost of equity capital and determine an investment's intrinsic value.
CAPM: Introduction & Teaching Issues - Richard DiamondRichard Diamond
The document provides an introduction to the Capital Asset Pricing Model (CAPM) by explaining its development, statistical workings, and applications in financial management. It also discusses pedagogical issues in presenting CAPM to undergraduate students, emphasizing the need for step-by-step explanations and demonstrating the practical inputs and outputs of the model.
Throughout this presentation, you’ll learn:
General risks faced by banking institutions on the financial markets.
How the main banking regulatory bodies’ actions are framing the banking industry (FRTB, TLAC, etc.).
About the application of Value-at-Risk (VaR) and Expected Shortfall (ES) as portfolio risk measures.
Complementary techniques to VaR and ES: Sensitivity Analysis (Greeks), Stress-testing.
Link between VaR & ES and regulatory capital.
This document discusses convex risk parity and tail risk management strategies for CVA/XVA portfolios. It notes that CVA/XVA desks manage portfolios rather than perfectly hedge risks, and that these risks involve fat tails. It then discusses convex risk parity and tail management approaches. Specifically, it covers risk parity strategies, criticisms of risk parity, and developments like tail risk parity that focus on drawdown protection rather than just volatility. It also discusses portfolio theory considerations regarding drawdown aversion rather than just volatility. The document aims to provide practical portfolio strategies for managing CVA/XVA and cross-asset portfolios with a focus on tail risks.
CAPM was developed in 1960 as an extension of Markowitz's portfolio theory. It derives the relationship between expected return and risk of individual securities. CAPM assumes investment decisions are based on risk-return assessments and that markets are efficient. It allows investors to combine risky and risk-free assets on the efficient frontier to maximize return for a given level of risk. The model is used to price individual securities based on their beta and expected market return.
Capital Asset Pricing Model (CAPM) was introduced in 1964 as an extension of the Modern Portfolio Theory which seeks to explore the diverse ways by which investors can construct investment portfolios through means that can possibly minimize risk levels and at the same time ensure maximization of returns.
Chapter 13 basel iv market risk frameworkQuan Risk
The document summarizes the Basel IV framework for managing market risk. It introduces the four pillars of Basel IV - minimum capital requirements, supervisory review, public disclosure, and liquidity sufficiency. It then discusses the regulatory approaches to calculating market risk capital charges, including the internal models approach and standardized approach. The internal models approach uses an expected shortfall model and requires significant regulatory approval. The standardized approach uses a variance-covariance method and is simpler but less risk sensitive.
Stress testing involves simulating the impact of exceptional but plausible risk factor changes on a bank's financial position. BASIC Bank uses stress testing techniques to quantify the effects of changes in credit, interest rate, exchange rate, equity price, liquidity, and other risks. Scenarios are developed to assess the bank's resilience under various adverse conditions, such as increases in non-performing loans, falls in collateral values, or defaults by major borrowers.
Measuring risk essentials of financial risk managementChho Phet
The document discusses various methods of measuring financial risk. It covers measures of exposure like risk exposure calculations, gap analysis, and stress testing. It then discusses value-at-risk (VaR) as a common measure of market risk, how it estimates potential portfolio losses based on historical data, and how it can be calculated using variance-covariance models or historical simulation. Monte Carlo simulation is also mentioned as another technique for calculating VaR.
Regulatory reporting of market risk under the basel iv frameworkQuan Risk
This document provides an overview of regulatory market risk capital requirements under the Basel IV framework. It discusses the expected shortfall approach and standardized variance-covariance method for calculating market risk capital charges. The internal model approach uses an bank's expected shortfall model and is more risk sensitive but also more complex and stringent. The standardized approach applies standardized calculations and correlation coefficients specified in Basel IV and is simpler but less risk sensitive.
Risk, Return, & the Capital Asset Pricing ModelHarish Manchala
This document discusses risk and return concepts including stand-alone risk, market risk, diversification, and the capital asset pricing model (CAPM). It defines key terms like beta, expected return, standard deviation, and the security market line. The document also provides examples of calculating beta for an individual stock and using the CAPM to determine the required return for different investments based on their level of market risk.
Regulatory reporting of market risk underthe Basel III frameworkQuan Risk
This document provides an overview of regulatory reporting requirements for market risk. It discusses the internal model method and standardized method for calculating market risk capital charges (MRCC) according to Basel III rules. The internal model method uses value-at-risk (VaR) models to calculate charges and requires regulatory approval. The standardized method applies fixed capital ratios to positions to calculate charges and has less risk sensitivity but also less regulatory requirements.
1) Asset/liability management (ALM) is the process of making decisions about the composition of a bank's assets and liabilities in order to manage risks and ensure sustainable profits.
2) ALM decisions are typically made by a bank's asset/liability management committee (ALCO) and involve strategic balance sheet management to match assets and liabilities.
3) The goal of ALM is to manage sources and uses of funds with respect to interest rate risk and liquidity risk arising from mismatches between assets and liabilities.
This document discusses risk and the Capital Asset Pricing Model (CAPM). It defines CAPM as a framework for determining expected returns based on systematic risk. CAPM shows that the expected return of an asset is determined by its beta, a measure of non-diversifiable risk relative to the market. The document outlines the key elements of CAPM including the capital market line, security market line, systematic and unsystematic risk, beta, and the CAPM formula. It also lists the assumptions of CAPM and provides explanations of systematic and unsystematic risk.
The chapter discusses the Capital Asset Pricing Model (CAPM). It introduces the efficient frontier and capital market line. The CAPM hypothesizes that the expected return of an asset is determined by its sensitivity to non-diversifiable risk, as represented by beta. All rational investors will hold the market portfolio and use leverage/borrowing according to their risk tolerance. The CAPM is used to determine the required rate of return for assets and their cost of equity.
Capital Asset Pricing Model, CAPM Assumptions, Borrowing and Lending Possibilities, Risk-Free Lending, Borrowing Possibilities, The New Efficient Set, Portfolio Choice, Market Portfolio, Characteristics of the Market Portfolio, Capital Market Line, The Separation Theorem, Security Market Line, CAPM’s Expected Return-Beta Relationship, How Accurate Are Beta Estimates?,
Capital Asset Pricing Model (CAPM)
A model that describes the relationship between risk and expected return. The general idea behind CAPM is that investors need to be compensated in two ways: time value of money & risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk gauge (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).
Operational Risk Loss Forecasting Model for Stress TestingCRISIL Limited
Presentation on ‘Operational Risk Loss Forecasting Model for Stress Testing – A Three-Stage Approach’ made by Dr. James Lu, Director, Risk & Analytics, CRISIL Global Research & Analytics (GR&A) at The 17th Annual OpRisk North America 2015, New York
This document provides an overview of asset-liability management (ALM) systems for banks and financial institutions. It discusses why ALM is important due to factors like globalization, deregulation, and integration of markets. The key objectives of ALM are to manage liquidity risk, interest rate risk, currency risk, and to aid in profit planning and growth projections. Specific risks like credit, market and operational risks are also discussed. The document outlines the ALM process, including generating statements to measure liquidity mismatches and interest rate sensitivity over different time periods. Tools for analyzing liquidity and interest rate risk are also presented. Overall organizational structure for effective ALM implementation is emphasized.
The document discusses the Capital Asset Pricing Model (CAPM). It explains that CAPM provides a framework to determine the required rate of return on an asset based on its relationship to risk. It also discusses the model's assumptions and how beta is used to measure non-diversifiable risk. Further, it shows how CAPM is used to estimate the cost of equity capital and determine an investment's intrinsic value.
CAPM: Introduction & Teaching Issues - Richard DiamondRichard Diamond
The document provides an introduction to the Capital Asset Pricing Model (CAPM) by explaining its development, statistical workings, and applications in financial management. It also discusses pedagogical issues in presenting CAPM to undergraduate students, emphasizing the need for step-by-step explanations and demonstrating the practical inputs and outputs of the model.
Throughout this presentation, you’ll learn:
General risks faced by banking institutions on the financial markets.
How the main banking regulatory bodies’ actions are framing the banking industry (FRTB, TLAC, etc.).
About the application of Value-at-Risk (VaR) and Expected Shortfall (ES) as portfolio risk measures.
Complementary techniques to VaR and ES: Sensitivity Analysis (Greeks), Stress-testing.
Link between VaR & ES and regulatory capital.
This document discusses convex risk parity and tail risk management strategies for CVA/XVA portfolios. It notes that CVA/XVA desks manage portfolios rather than perfectly hedge risks, and that these risks involve fat tails. It then discusses convex risk parity and tail management approaches. Specifically, it covers risk parity strategies, criticisms of risk parity, and developments like tail risk parity that focus on drawdown protection rather than just volatility. It also discusses portfolio theory considerations regarding drawdown aversion rather than just volatility. The document aims to provide practical portfolio strategies for managing CVA/XVA and cross-asset portfolios with a focus on tail risks.
In many organisations, Procurement is beginning to see Risk as part of their responsibilities, second only to savings. In this presentation we will look at identifying risk and consider how it might be treated to arrive at the best Risk solution for your organisation.
Regulations and standards have evolved in response to issues revealed by the 2007 financial crisis. Basel 2 aimed to better capture credit, market, and operational risk, while Basel 2.5 focused on risks from extreme events and Basel 3 aimed to strengthen capital requirements and address systemic risk and liquidity risk. Accounting standards like IFRS 9 and IFRS 13 also evolved to converge with prudential rules regarding areas like impairment models and fair value measurement. The standards have broadened in scope to establish more comprehensive frameworks for risk management across different areas.
This document discusses regulations and standards that govern the banking system. It provides context on factors that drive regulations, including the 2007-2008 financial crisis which revealed shortcomings in risk management. Major standards discussed include Basel II, Basel 2.5, Basel III, IFRS 9, and IFRS 13. Each standard addresses specific objectives like strengthening capital requirements, managing liquidity risk, and increasing transparency. The document also outlines the principles and objectives of the various standards, with a focus on Basel II, Basel 2.5, and how they aim to improve risk measurement and management.
(R)isk Revolution - Current trends and challenges in Credit & Operational RiskMarkus Krebsz
This was presented as part of a Senior Australian Bankers' Master Class held at GCU London on 19 Sept 2012. Dr. Robert Webb was co-presenting on the UK & European Banking system.
International Association of Risk and Compliance Professionals (IARCP)
http://www.risk-compliance-association.com
Every Monday
Top 10 risk and compliance management related news stories and world events
Do you want to receive (at not cost) every Monday the Top 10 risk and compliance management related news stories and world events that (for better or for worse) shaped the week's agenda, and what is next?
You can register at:
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You will have the opportunity to learn (at not cost) what members registered before you have already learned. Understand better risk and compliance management, projects, careers, challenges and opportunities.
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CAIIB Super Notes: Bank Financial Management: Module D: Balance Sheet Managem...PsychoTech Services
This document discusses liquidity management in banks. It defines liquidity as a bank's ability to meet deposit withdrawals and fund loan demands. The key aspects of liquidity management covered include:
1. Measuring and managing liquidity risk using the stock and flow approaches. The flow approach involves constructing a maturity ladder to assess net funding requirements over time horizons.
2. Setting tolerance limits for liquidity risk metrics like loan-to-deposit ratios to ensure adequate liquidity buffer.
3. Developing a liquidity risk management framework involving board oversight, risk measurement processes, and contingency planning for liquidity crises.
4. Managing liquidity in foreign currencies requires decisions around centralized vs decentralized management
Quantifi whitepaper how the credit crisis has changed counterparty risk man...Quantifi
This paper will explore some of the key changes to internal counterparty risk management processes by tracing typical workflows within banks before and after CVA desks, and how increased clearing due to regulatory mandates, affects these workflows. Since CVA pricing and counterparty risk management workflows require extensive amounts of data, as well as a scalable, high-performance technology, it is important to understand the data management and analytical challenges involved.
• Current trends and best practices
• Key data and technology challenges
Cost of Trading and Clearing OTC Derivatives in the Wake of Margining and Oth...Cognizant
We examine how recent regulatory changes (in central clearing, margin requirements, etc.) are impacting the OTC derivatives market, and causing several leading players to exit. With the spike in clearance and trading costs, a multitude of ratios show how firms are likely to adjust.
Vskills certification for Fixed Income Professional assesses the candidate as per the company’s need for their fixed income financing business. The certification tests the candidates on various areas in price-yield conventions, monetary policies, compounding, dv01/pvbp¸treasury debt securities, repo agreements, modeling, mortgages, Eurodollar futures, credit default swaps, treasury futures contracts, OIS, interest-rate swaps and treasury futures contracts.
This chapter discusses the risks associated with off-balance sheet activities at financial institutions. While off-balance sheet activities are often used to hedge risks, they can also pose substantial risks as demonstrated by several high-profile cases of losses. Regulatory policies have been updated in response to accounting issues and unethical practices related to off-balance sheet activities. Off-balance sheet activities include derivatives, contingent assets and liabilities, and other transactions recorded off a company's balance sheet.
The document discusses asset liability management (ALM) in banks. It describes the key components of a bank's balance sheet and profit and loss account. It then discusses the evolution of ALM from a focus on asset management to incorporating liability management and interest rate risk management. The document defines ALM and describes the tools used: information systems, organizational structure, and processes. It also outlines the main risks managed under ALM - liquidity risk, currency risk, and interest rate risk - and provides techniques to measure and manage these risks.
Impact of Valuation Adjustments (CVA, DVA, FVA, KVA) on Bank's Processes - An...Andrea Gigli
The talk hold in London on September 10th at the 5th Annual XVA Forum on Funding, Capital and Valuation. It covered some implications of Valuation Adjustments like CVA, DVA, FVA and KVA (XVAs) in the Pricing of Derivatives, Data Model Definition, Risk Management, Accounting, Trade Workflow processing.
FX Reset: Risk Reduction Trade-offs & Hedging Costs in the Crisis MarketKyriba Corporation
This document summarizes a webinar about managing foreign exchange (FX) risk during periods of high volatility. The webinar teaches how to assess full FX exposure, risk, and costs using a cost and risk efficiency analysis. It identifies specific steps to reduce costs and risks and keep executives informed. FX risk is a major concern for CFOs and treasurers due to unhedged exposures costing companies. The webinar demonstrates Kyriba's FX CoRE analysis tool, which benchmarks FX exposure and risk to recommend hedging strategies that minimize risk and costs.
The document provides an agenda for an energy industry session on risk management. The session will include presentations on asset valuation during development and production, energy project financing in emerging markets, understanding risk allocation in drilling contracts, and risk management services. There will also be a roundtable discussion on current issues. The agenda lists the session coordinator and speakers along with short biographies. It provides an overview of the topics to be covered and notes that a survey of popular Texas country and western songs among risk managers will be included.
OTC Collateralisation : implementations issues in the context of CVA & FVA
- The ideal CSA hypothesis : Imperfect collateralisation for credit mitigation and/or funding
- FVA vs. CSA-discounting
- Implications in terms of curves calibrations and management
- FVA for Cleared positions
- FVA or CSA-discounting : which funding management model?
Risk Management at Wellfleet Bank: All That Glitters Is Not GoldHira Naz
Case Study Solution: Gatwick Gold Corporation
Case Study Solution: Gatwick Gold Corporation
Risk Management at Wellfleet Bank: All That Glitters Is Not Gold
Advanced Financial Risk Management
Institute of Business Management
Webinar: Real-time Risk Management and Regulatory Reporting with MongoDBMongoDB
Real-time risk management coupled with the requirements for regulatory reporting are top of mind for many heads of risk. In this webinar, we will cover how MongoDB can help with:
Implementing proactive risk controls
Aggregated Risk on Demand
Creating an Adaptive Regulatory Reporting Platform
Cost Effective Risk Calculations
Similar to xVAs The Post-Lehman Derivatives Valuation Adjustments (20)
13 Jun 24 ILC Retirement Income Summit - slides.pptxILC- UK
ILC's Retirement Income Summit was hosted by M&G and supported by Canada Life. The event brought together key policymakers, influencers and experts to help identify policy priorities for the next Government and ensure more of us have access to a decent income in retirement.
Contributors included:
Jo Blanden, Professor in Economics, University of Surrey
Clive Bolton, CEO, Life Insurance M&G Plc
Jim Boyd, CEO, Equity Release Council
Molly Broome, Economist, Resolution Foundation
Nida Broughton, Co-Director of Economic Policy, Behavioural Insights Team
Jonathan Cribb, Associate Director and Head of Retirement, Savings, and Ageing, Institute for Fiscal Studies
Joanna Elson CBE, Chief Executive Officer, Independent Age
Tom Evans, Managing Director of Retirement, Canada Life
Steve Groves, Chair, Key Retirement Group
Tish Hanifan, Founder and Joint Chair of the Society of Later life Advisers
Sue Lewis, ILC Trustee
Siobhan Lough, Senior Consultant, Hymans Robertson
Mick McAteer, Co-Director, The Financial Inclusion Centre
Stuart McDonald MBE, Head of Longevity and Democratic Insights, LCP
Anusha Mittal, Managing Director, Individual Life and Pensions, M&G Life
Shelley Morris, Senior Project Manager, Living Pension, Living Wage Foundation
Sarah O'Grady, Journalist
Will Sherlock, Head of External Relations, M&G Plc
Daniela Silcock, Head of Policy Research, Pensions Policy Institute
David Sinclair, Chief Executive, ILC
Jordi Skilbeck, Senior Policy Advisor, Pensions and Lifetime Savings Association
Rt Hon Sir Stephen Timms, former Chair, Work & Pensions Committee
Nigel Waterson, ILC Trustee
Jackie Wells, Strategy and Policy Consultant, ILC Strategic Advisory Board
“Amidst Tempered Optimism” Main economic trends in May 2024 based on the results of the New Monthly Enterprises Survey, #NRES
On 12 June 2024 the Institute for Economic Research and Policy Consulting (IER) held an online event “Economic Trends from a Business Perspective (May 2024)”.
During the event, the results of the 25-th monthly survey of business executives “Ukrainian Business during the war”, which was conducted in May 2024, were presented.
The field stage of the 25-th wave lasted from May 20 to May 31, 2024. In May, 532 companies were surveyed.
The enterprise managers compared the work results in May 2024 with April, assessed the indicators at the time of the survey (May 2024), and gave forecasts for the next two, three, or six months, depending on the question. In certain issues (where indicated), the work results were compared with the pre-war period (before February 24, 2022).
✅ More survey results in the presentation.
✅ Video presentation: https://youtu.be/4ZvsSKd1MzE
In World Expo 2010 Shanghai – the most visited Expo in the World History
https://www.britannica.com/event/Expo-Shanghai-2010
China’s official organizer of the Expo, CCPIT (China Council for the Promotion of International Trade https://en.ccpit.org/) has chosen Dr. Alyce Su as the Cover Person with Cover Story, in the Expo’s official magazine distributed throughout the Expo, showcasing China’s New Generation of Leaders to the World.
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Poonawalla Fincorp Limited, under the leadership of Managing Director Abhay Bhutada, has achieved industry-leading Gross Non-Performing Assets (GNPA) below 1% and Net Non-Performing Assets (NNPA) below 0.5% as of May 31, 2024. This success is attributed to a strategic vision focusing on prudent credit policies, robust risk management, and digital transformation. Bhutada's leadership has driven the company to exceed its targets ahead of schedule, emphasizing rigorous credit assessment, advanced risk management, and enhanced collection efficiency. By prioritizing customer-centric solutions, leveraging digital innovation, and maintaining strong financial performance, Poonawalla Fincorp sets new benchmarks in the industry. With a continued focus on asset quality, digital enhancement, and exploring growth opportunities, the company is well-positioned for sustained success in the future.
How to Invest in Cryptocurrency for Beginners: A Complete GuideDaniel
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Cryptocurrencies can be used for various purposes, including online purchases, investment opportunities, and as a means of transferring value globally without the need for intermediaries like banks.
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Navigating Your Financial Future: Comprehensive Planning with Mike Baumannmikebaumannfinancial
Learn how financial planner Mike Baumann helps individuals and families articulate their financial aspirations and develop tailored plans. This presentation delves into budgeting, investment strategies, retirement planning, tax optimization, and the importance of ongoing plan adjustments.
In World Expo 2010 Shanghai – the most visited Expo in the World History
https://www.britannica.com/event/Expo-Shanghai-2010
China’s official organizer of the Expo, CCPIT (China Council for the Promotion of International Trade https://en.ccpit.org/) has chosen Dr. Alyce Su as the Cover Person with Cover Story, in the Expo’s official magazine distributed throughout the Expo, showcasing China’s New Generation of Leaders to the World.
xVAs The Post-Lehman Derivatives Valuation Adjustments
1. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
xVAs: The Post–Lehman Derivatives Valuation
Adjustments
Alex Kouam 1
Master of Science International Banking and Finance (Strathclyde Business School)
Specialized Master Quantitative Finance (EMLYON Business School)
31st August 2017
1
Unauthorised use prohibited Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
2. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Outline I
1 General Market Business Activties Risks
2 Treasurer Activities
3 Banking Regulation
Stakeholders, Geographical Scope and Roles
Current EU Regulation
4 xVAs
5 CVA
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
6 CVA Risk Mitigation Techniques
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
3. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Outline II
Collateralization
Netting Agreements
Hedging
7 FVA
8 ColVA
9 KVA
10 Challenges brought up by the xVAs
11 Conclusion
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
4. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
General Market Business Activties Risks
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
5. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
General Market Business Activties Risks I
Credit Risk stands for the risk of a counterparty defaulting on
payment obligations
E.g.: Enron (2001) declared a loss of $1 billion in October 2001 with
revalued libabilities of over $60 billion at the bankruptcy filing.
Liquidity Risk (Funding) is the risk that the cost of funding
becomes higher, up to the extreme case when raising funds become
impossible.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
6. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
General Market Business Activties Risks II
E.g. Northern Rock (2007) were unable to sell securitized loans to
secure funding.
Market Risk is the risk of adverse deviations from the
mark–to–market value of the trading portfolio, due to market
movements, during the period required to liquidate the transactions.
E.g. JP Morgan (2012) incurred mark–to–market losses of $6.2 billion
on the Synthetic Credit Portfolio
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
7. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
General Market Business Activties Risks III
Operational Risk outcomes from direct or indirect loss resulting from
inadequate or failed internal processes, people and systems or from
external events.
E.g. Barings (1995), Soci´et´e G´en´erale (2008) and UBS (2011) lost
respectively $1.4 billion, e4.9 billion and £1.4 billion because of rogue
traders who managed to deceive internal control systems.
Counterparty credit risk is the risk that the counterparty to a
financial contract will default prior to the expiration of the contract
and will not make the payments required by the contract.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
8. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
General Market Business Activties Risks IV
E.g. American International Group (AIG) which wrote more than
$500bn of Credit Default Swaps contracts and was unable to post
further collateral when the turmoil in the housing market reached its
climax.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
9. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Treasurer Activities
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
10. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Activities of a Treasurer
Secure term funding.
Ensure liquidity for derivatives trading.
Transferring these costs to the business.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
11. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Stakeholders, Geographical Scope and Roles
Current EU Regulation
Banking Regulation
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
12. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Stakeholders, Geographical Scope and Roles
Current EU Regulation
Missions
In a nutshell, banking regulation aims to:
Guarantee the financial system resilience and integrity, the economy’s
lifeblood and,
Protect financial products’ consumers, in particular to maintain a high
level of confidence in the system.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
13. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Stakeholders, Geographical Scope and Roles
Current EU Regulation
Table
Institutions Geographical Coverage Roles
G20 World • The G20 set top priorities
FSB • FSB makes those priorities operational
Basel Committee • The Basel Committe publishes
these recommendations
European Parliament Europe • The Euopean institutions adapt
European Commission these recommendations to the
EBA European context through
Capital Requirements Regulation
(CRR) and Capital Requirements
Directive (CRD)
French Parliament France •They adopt the EU agencies directives
ACPR with respect to the French law
CCLRF
Table: Main Regulatory BodiesAlex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
14. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Stakeholders, Geographical Scope and Roles
Current EU Regulation
Current EU Regulation
Issue Key Points
SA–CCR • CEM and SM are replaced by
SA–CCR
• A modified Original Exposure
method is retained
CVA •a failure to meet FRTB–CVA
requirements will lead to a
fallback to the BA–CVA
(higher capital requirements)
Table: EC CRR Amendments
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
15. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
xVAs
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
16. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
xVAs: Overview
Adjustment Target Objectives Market driver(s)
CVA Uncollateralised derivatives Anticipates on future costs IFRS 13
caused by the counterparty’s Basel 3
creditworthiness deterioration
FVA Uncollateralised derivatives Captures the funding NSFR, LCR
costs/gains of TLAC (G–SIBs)
derivatives above the”risk–free” IFRS 13 (DVA)
rate.
ColVA Collateralised derivatives Captures cost of funding a Cheapest to deliver
derivative position at collateral
new ”risk free” rate
KVA All the derivatives book Aims to capture cost of holding regulatory CVA/CCR Capital Charge
capital as a result of the derivative position Leverage Ratio, Market Risk
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
17. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CVA
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
18. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR: Origins I
Through deposits, investments, OTC derivatives or securities
financing transactions, the treasurer will create credit exposure.
This credit exposure is defined as the cost of replacing the transaction
if the counterparty defaults (assuming no recovery value).
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
19. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR: Specific Properties I
Unlike other forms of credit risk, this credit exposure features asymmetric
characterisrics:
If the company is owed money and the counterparty defaults then the
company will incur a loss whereas
In the reverse, the company will not gain from the default by being
released from their liability.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
20. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Some Credit Exposures Metrics I
In order to efficiently manage her credit exposure, our treasurer needs
to build metrics which provides answers to the following questions:
What is the maximum loss if the counterparty defaults now?
What could be the loss if the counterparty defaults at some point in the
future?
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
21. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Some Credit Exposures Metrics II
If we define the Mark–to–Market (MtM) as the value of a transaction
at some point in the future, our treasurer could summarize her credit
exposure using the three following metrics:
Potential Future Exposure (PFE): attempts to answer the first
question. Although, the PFE is sometimes referred as the VaR
analogue for CCR, it differs from this latter not only on the focus of
the exposure signs but also usually covers much longer periods than
the VaR. Mathematically, PFEα is:
PFEα(t) = max (MtM (0; t) , 0)
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
22. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Some Credit Exposures Metrics III
Expected Exposure (EE): represents the expected amount to be lost
if the counterparty defaults. Mathematically:
EE(t) = E [max (V (t) , 0)]
=
∞
0
xdF[0,t](x)
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
23. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Some Credit Exposures Metrics IV
Expected Positive Exposure (EPE): Given the lenghty term of
derivatives, the EPE will measure EE across the time. Mathematically,
EPE(0; t) = E
1
t
t
0
EE(s)ds
=
1
t
t
0
EE(s)ds
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
24. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Exposure Metrics: Illustration I
Parameters
µ(%) σ(%) α(%) EPE
0 10 95 8,529
Table: Exposure of a Forward Contract
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
25. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Exposure Metrics: Illustration II
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
26. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR: Quantification aims
trade approval by comparing against credit lines (PFE).
pricing (and hedging) CCR.
calculating economic and regulatory capital.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
27. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR: Quantification Methods I
We have two main methods to quantify CCR:
1 Mark–to–market + add–ons: Take the positive MtM and add a
component. That component depends on:
time horizon (larger add–on for long–term transaction)
volatility of the underlying asset class (Higher volatility for FX and
commodities)
the nature of the underlying transaction(s) (higher add–on for
non–G10 currencies.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
28. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR: Quantification Methods II
2 Monte–Carlo simulation: more complex and time–consuming but
can cope with add–on’s ignored complexities such as transaction
specifics, path dependency, etc. . . .
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
29. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR Quantification: Monte–Carlo simulation (MCS) I
The steps for a MCS quantification are:
1 Factor Choice: Select the risk factor(s) that influence the exposure
of the transaction. E.g. Spot interest rate, FX, etc. . .
2 Scenario Generation: Generate scenario of risk factors in which each
scenario represents a joint realisation of risk factors at various point in
time.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
30. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR Quantification: Monte–Carlo simulation (MCS) II
3 Revaluation: Use the values generated at step 2 to revalue the
position at each point in time in the future.
4 Aggregation: Aggregate those values up to the netting set. This
step requires a knowledge of the netting agreements.
5 Post–Processing We go through each exposure path, determine at
each point how much the exposure would be collateralized and apply.
6 Extraction of Statistics: At this step, you can easily extract the
metrics that we did cover earlier.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
31. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CCR Quantification: Monte–Carlo simulation (MCS) III
Roll–off risk
Exposures will be calculated at only discrete time points and we can
miss any key area.
Incorporate the critical points where exposures change significantly
into the time grid.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
32. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
PD I
We saw earlier that exposure depends on the counterparty’s default,
then an assessment of the default probability term structure is also
crucial for risk manangement.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
33. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
PD II
Our treasurer needs to consider two aspects:
What is the probability of the counterparty defaulting in a certain time
horizon?
What is the probability of the counterparty suffering a decline in credit
quality over a certain time horizon?
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
34. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
PD: Definition I
The probability of default between two future dates u1 and u2, where
u1 ≤ u2, is:
q (u1, u2) = S (u1) − S (u2)
= F (u2) − F (u1)
where, S (u) is the probability of no default prior to a certain time u and
F (u) = 1 − S (u) is the cumulative probability of default prior to a certain
time u
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
35. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
CDS Illustration on a single reference entity
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
36. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Market–Implied Probabilities
Here the default probability is worked out by calibrating a hazard rate h
which defines the probability of default in a small interval dt
S (u) = exp (−hu)
where h ≈ XCDS
(1−δ)
XCDS is the CDS premium and δ is constant recovery rate.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
37. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Intersection Methodology I
The EBA (2012) has been laying down rules as part of CRD IV about
the way illiquid counterparty’s spreads should be proxied.
The Intersection Methodology consists of aggregating data across
the relevant rating, region, sector sub–categories. Mathematically:
Sproxy
i =
1
N
N
j=1
S (j)
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
38. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Intersection Methodology II
Where N ≥ 1 is the number of liquid names in the same rating,
region, sector sub–categories as obligor i and
S (j) is their spread levels.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
39. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Historical Probabilities
This consist of using the ratings from the prominent rating agencies
(Standard & Poor’s, Moody’s, Fitch) to predict future default likelihood
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
40. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
PD: Gap between Historical and Market–implied
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
41. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Equity–based approach I
Merton (1974) states that default happens by the time that a firm’s asset value (Vt )
falls beneath its debt’s book value (B).
Assumptions:
Market is perfect (no dividends, no taxes,...).
Firm’s asset value follows a geometric Brownian motion.
The single class of debt (B) maturity matches the time period under scrutiny
(usually one year).
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
42. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Equity–based approach II
Firm’s capital structure is only made up of equity (Et ) and a zero–coupon bond
(B).
Pt = P [VT < B]
...
= Φ −
log Vt
B
+ α − 1
2
σ2
V (T − t)
σV
√
T − t
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
43. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
LGD
The loss given default (LGD) measures the percentage of all exposure at
the time of default that cannot be recovered
LGD is related to the recovery rate(RR) using the following relationship:
LGS = 1 − RR where RR is usually assumed as a constant
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
44. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
LGD: Equity–based approach
But if we aim to be consistent with the PD’s equity–based approach, we can work out
the implied RR as such:
E
VT
B
|VT < B =
1
B
E [VT |VT < B]
...
=
V0
B
exp (αT)
Φ −
log
V0
B
+ α+
σ2
V
2
T
σV
√
T
Φ −
log
V0
B
+ α−
σ2
V
2
T
σV
√
T
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
45. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Counterparty Credit Risk (CCR)
Probability of Default (PD)
Loss Given Default (LGD)
Pricing CVA: No Wrong–way Risk
CVA is usually tagged as the price of CCR because the move to either enter
into a new transaction with a counterparty depends upon whether or not
this latter will be profitable once you ”price in” its CCR. Mathematically:
˜V (t, T) = V (t, T) − EQ
(1 − δ) I (τ ≤ T) V (τ, T)+ β(s)
β(τ)
CVA
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
46. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
CVA Risk Mitigation Techniques
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
47. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
CCR: Controlling Techniques I
The methods for doing this predominantly focus on reducing current credit
exposure and potential future exposure.
Default–remote entities: The use of an institution or vehicle with a
low underlying default probability. E.g. SPV, CCP.
Termination events: provides the opportunity to terminate a
transaction at some point(s) between inception and maturity date.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
48. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
CCR: Controlling Techniques II
Netting: allows two parties to net a set of positions(explicitly covered
by the netting agreement) in the event of default of one of them.
Close–out: allows the termination of all contracts between the
insolvent and a solvent counterparty without waiting for the
bankruptcy to be finalised.
Collateralisation: The agreement that cash or other securities will
be posted as a guarantee against an exposure according to
pre–defined parameters.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
49. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Collateralization: Aims I
In the aftermath of the GFC, collateral use to reduce CCR has
substantially increased.
According to ISDA (2010), more than 70% of all OTC derivatives
transactions were collateralized. The aims of collateral management
are:
Reduce credit exposure so as to be able to do more business.
Enables ones to trade with a particular counterparty. For instance,
restricted rating may not allow uncollateralized transactions,
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
50. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Collateralization: Aims II
Reduce capital requirement
To give more competitive CCR’s pricing.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
51. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Collateralization: The Basics
In a swap transaction between parties A and B, party A makes a MtM
profit whilst party B makes a corresponding MtM loss.
Party B posts some form of collateral (cash or other securities) to
party A to cover against party A’s positive MtM.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
52. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Types of collateral I
Cash
Government securities
Government agency securities (e.g. Fannie Mae/Freddie Mac).
Mortgage–backed securities (MBSs).
Corporate bonds/ commercial paper.
Letters of credit and guarantees.
equity
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
53. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Composition of a Collateral Agreement I
Base currency
Type of agreement (one–way or two–way): Is one or both that have
to post collateral in the case of negative MtM?
Quantification of parameters: Independent amount, threshold,etc. . .
Eligible collateral to be posted alongside with applicable haircuts.
Timings regarding the delivery of collateral (margin call frequency,
notification times and delivery periods)
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
54. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Composition of a Collateral Agreement II
Interest rate payables on cash collateral.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
55. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Collateralization: The Mechanics I
The elements covered by a typical Credit Support Annex (CSA) are:
Independent Amount(IA): or initial margin corresponds to a
quantity of collateral that is posted upfront and is independent of any
subsequent collateral. It is typically held as a cushion against the risk
that the market value of a transaction may fall substantially in a short
space of time (”Gap risk”).
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
56. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Collateralization: The Mechanics II
Margin call frequency: refers to the periodic timescale with which
collateral may be called and returned.
Threshold: is a level of exposure below which collateral will not be
called and hence any exposure within the threshold will be
uncollateralised.
Minimum Transfer amount (MTA): is the smallest amount of
collateral that can be transferred and is used to avoid cumbersome
transfer of insignificant amounts of collateral.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
57. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Collateralization: The Mechanics III
Rounding: A collateral call or return will always be rounded to a
certain lot size to avoid unnecessarily small amounts.
Haircuts: are discount applied to the value of collateral to account
for the fact that its value may deteriorate over time. These discounts
are applied on all collateral excluding cash.
Coupons and interest payments: Interest will be typically paid on
cash collateral at an overnight rate (EONIA, Fed Funds,etc. . . )
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
58. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Risks of Collateralization I
Although collateralisation has the benefits of undermining the underlying
market risk, this mitigation technique creates other risk such as:
1 Operational Risk: missed collateral calls, failed deliveries, unsuitable
IT systems, etc. . . .
2 Default Risk: Default relating to a security posted as collateral would
clearly reduce the value of that collateral substantially and the applied
haircut is very unlikely to cover such an event
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
59. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Risks of Collateralization II
3 FX Risk: When two counterparties do not have the same local
currency, one of them will have to take FX risk linked to the collateral
posted.
4 Liquidation Risk: risk that by liquidating an amount of a security that
is large compared with the volume traded in that security.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
60. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Netting Agreements
A netting agreement is a legally binding contract that allows
aggregation of transactions if either of counterparty defaults.
Across netting sets, exposure will always be positive, whereas within a
netting set, MtM values can be added.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
61. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
The drawbacks of Netting
Netting is heavily dependent of the type of underlying involved.
Legal issues regarding the enforceability of netting could undermine
this latter’s benefits in the case that trades are booked with different
legal entities across different regions.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
62. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Hedging
This step involves many different market variables and the potential
linkage between them.
Hedging will be far from perfect and the most pragmatic solution is to
identify the key compoents of CVA that can and should be hedged, as
well as those that cannot.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
63. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Hedging CVA: Not a Risk–Neutral Problem I
Although Black–Scholes managed to create the link between the price of
an option and a dynamic hedging strategy, some important point to be
stressed when hedging CVA:
Variables: CVA usually embeds several underlying risk factors
(interest rates, FX rates and credit spreads)
Cross–dependency: CVA is a complex credit hybrid payoff because
the dependency between underlying factors might be non–trivial.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
64. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Hedging CVA: Not a Risk–Neutral Problem II
Term Structure: CCR is characterised by long–term trades and
hedging one underlying risk factor sensitive to term structure may
involve position in hedgings with different maturity dates.
Inability to hedge some variables: Some impactful parameters (e.g.
credit parameters) to the CVA cannot be hedged either because there
is no existence of an instrument with the required sensitivity or the
hedging costs are high.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
65. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateralization
Netting Agreements
Hedging
Hedging CVA: Not a Risk–Neutral Problem III
Lack of arbitrage: In order for an arbitrageur to take advantage of a
CCR mispricing error of an institution A on B, they need to trade with
institution A a contract referencing the credit quality of institution B.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
66. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
FVA
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
67. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Fund Valuation Adjustment I
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
68. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Fund Valuation Adjustment II
Since the outbreak of the GFC, there is a stark divergence between
the interbank lending/offering rate and the overnight rate.
FVA is divided into two components adjustments:
Funding Benefit Adjustment (FBA): arises when a bank acquires a
derivative in a liability position(negative MtM).
Funding Cost Adjustment (FCA): arises when a bank acquires a
derivative in an asset position(positive MtM).
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
69. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
ColVA
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
70. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateral Value Adjustment I
The choice of collateral impacts the discounting curve.
There’s a lot of optionality embedded in the current CSA agreements
where there allow collateral in cash or Treasury or corporate bonds in
various currencies.
It’s really important for the bank or the firm to identify which one will
be the cheapest to post because by minimizing the funding rate
(sborrow - spost) on collateral they will maximize their profit.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
71. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateral Value Adjustment II
Almost each agreement is unique (choice of collateral currency,
different thresholds, etc. . . ), then you will need to identify the
cheapest collateral possible for each trade.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
72. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Collateral Value Adjustment III
Not every cheapest to deliver collateral is the optimal choice and the right
approach before making a final choice should look the following aspects:
Analyze the funding rate.
Look at the available pool of assets.
Is cheaper to source new collateral or use existing one?
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
73. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
KVA
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
74. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
KVA: Origins
The subsequent capital requirements in the aftermath of the GFC set
substantial holding amounts of capital for derivative positions. And its
more punitive for non–centrally cleared derivatives.
Other xVAs focus on adjusting expected costs (losses) over the
lifetime of a transaction at present time.
But unexpected costs will also arise during the lifetime of the
transaction and KVA aims to capture it.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
75. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Definition and Drivers
KVA can be defined as the present value of the future capital costs
due to the various charges
KVA depends upon:
Counterparty nature: CCPs and many non–financials are exempt from
CVA charge and/or have lower CCR.
CSA(via CVA risk charge and credit exposure). Collateralization and
Initial Margin reduce CCR.
Availability of CDS protection to reduce CVA risk charge.
Diffusion models, measures, calibration.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
76. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Challenges brought up by the xVAs
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
77. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
CDS Gross Notional Graph
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
78. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Challenges brought up by the xVAs
How do I get the Credit curve of my counterparty? The CDS market
has not been very liquid over the last few years especially for
counterparty whose spreads is not traded on the market.
The cheapest to deliver pricing is very challenging.
FVA: What’s my funding cost (short, medium, long).
KVA: What return of capital do I want? Do we have to include tax
efficiency?
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
79. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Conclusion
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments
80. General Market Business Activties Risks
Treasurer Activities
Banking Regulation
xVAs
CVA
CVA Risk Mitigation Techniques
FVA
ColVA
KVA
Challenges brought up by the xVAs
Conclusion
Conclusion
Key Takeaways
The GFC abated the longstanding theory of a unique price for every
asset and ever since, derivative pricing depends upon the
characteristics of the trade.
Alignment of front office, accounting and regulation are still in the
flux (CVA/DVA). Banks who still used historical data and / or
internally–produced models parameters must design their processes
around market–implied parameters.
Alex Kouam xVAs: The Post–Lehman Derivatives Valuation Adjustments