Market risk captures the risk that the value of an instrument or portfolio will decrease as result of adverse movements in financial markets. Market risk encompasses a number of subtypes which are directly linked to a particular market risk factor (price or spread), namely interest rate risk, currency price risk (FX risk), equity price risk, commodity price risk, real estate price risk, inflation risk and credit spread risk.
Business & Decision RTC has proven expertise in the implementation of the essential tools for an efficient Market Risk Management, as well as the architecture and interfaces needed to gather the trade and market data:
** In the regulatory framework, VaR 99% will be replaced by cVaR 97,5% for the tracking portfolio
Models developed for the risk computation have to be revalidated regularly.
On one side, the second pillar of Basle regulation implies that supervisors check that risk models are always performing consistently. On the other side, recent crisis has drawn the attention of internal stakeholders of the bank (business, CRO) to a higher interest on the models.
The validation process consists in a review of the development process and all related aspects of model implementation. It can be split in two parts:
Regarding market risk specifically, backtesting is particularly important. In the formula to compute the regulatory capital, there is a factor whose value depends on the number of VaR violations during the last 12 months. However, the number of failures in itself is not enough to assess the validity of the VaR model: one should also considers at least the eventual dependence between the violations and their severity. A lot of tests have been introduced recently (see below White Paper on Backtesting of Value-at-Risk models): B&D RTC can help you in the implementation of those tests, understanding and analysing their results.
Date : 19/05/2015
Basel regulation provides a framework that links the regulatory capital to the Value at Risk. Banks have thus been obliged to implement VaR models, predicting future risks.
These models have to be regularly back-tested to prove their accuracy. A large variety of testing methods have been proposed in the scientific literature. The first goal of this document is to provide a survey of them and discuss their strengths and weaknesses. Then, it addresses some recommendations for an optimal methodology in testing.
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Experience has show that the Market Risk manager needs several essential tools:
Business & Decision has proven expertise in the implementation of those tools, as well as the architecture and interfaces needed to gather the necessary trade and market data in a timely fashion.
Business & Decision Risk Technology Consulting can assist with the technical and functional expertise in the key points of model development:
The context: The client, one of the top central clearing counterparty houses, has developed its own methodology to compute the initial margin and the stress testing, for FX options (listed and OTC).
The needs: The client wanted to assess the compliance of this new methodology with the requirements of European Market Infrastructure Regulation (EMIR). It also wished a re-evaluation of the revised margin model in the context of adequacy and prudency.
Software used: MatLab