market risk - its dimensions
TRANSCRIPT
Market Risk - Its dimensions
PKrishnamurthy
25 August 2012
1
ldquoBusiness is all about taking and managing
risk
What is bad is risk that is mismanaged
misunderstood mispriced and
unintendedrdquo
- CourtesyRoyal Bank of Canada
2
ldquo Rogue trading is probably a daily occurrence within the financial markets What shocked me was the size I never for one moment believed it would get
to this degree of magnitude this degree of loss rdquo
Nick Leeson Trader held responsible for the fall of Barings Bank in January 2008
3
Some thoughts helliphellip
4
Risk is Uncertainty of Outcomes
5
Events and Uncertainty
bull Risk can be priced by financial markets because it depends on known distribution of events to which investors assign probabilities and price things accordingly
bull Uncertainty on the other hand canrsquot be priced it relates to events conditions and possibilities that canrsquot be predicted measured or modeled
Frank HKnight 1921
6
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
ldquoBusiness is all about taking and managing
risk
What is bad is risk that is mismanaged
misunderstood mispriced and
unintendedrdquo
- CourtesyRoyal Bank of Canada
2
ldquo Rogue trading is probably a daily occurrence within the financial markets What shocked me was the size I never for one moment believed it would get
to this degree of magnitude this degree of loss rdquo
Nick Leeson Trader held responsible for the fall of Barings Bank in January 2008
3
Some thoughts helliphellip
4
Risk is Uncertainty of Outcomes
5
Events and Uncertainty
bull Risk can be priced by financial markets because it depends on known distribution of events to which investors assign probabilities and price things accordingly
bull Uncertainty on the other hand canrsquot be priced it relates to events conditions and possibilities that canrsquot be predicted measured or modeled
Frank HKnight 1921
6
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
ldquo Rogue trading is probably a daily occurrence within the financial markets What shocked me was the size I never for one moment believed it would get
to this degree of magnitude this degree of loss rdquo
Nick Leeson Trader held responsible for the fall of Barings Bank in January 2008
3
Some thoughts helliphellip
4
Risk is Uncertainty of Outcomes
5
Events and Uncertainty
bull Risk can be priced by financial markets because it depends on known distribution of events to which investors assign probabilities and price things accordingly
bull Uncertainty on the other hand canrsquot be priced it relates to events conditions and possibilities that canrsquot be predicted measured or modeled
Frank HKnight 1921
6
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Some thoughts helliphellip
4
Risk is Uncertainty of Outcomes
5
Events and Uncertainty
bull Risk can be priced by financial markets because it depends on known distribution of events to which investors assign probabilities and price things accordingly
bull Uncertainty on the other hand canrsquot be priced it relates to events conditions and possibilities that canrsquot be predicted measured or modeled
Frank HKnight 1921
6
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk is Uncertainty of Outcomes
5
Events and Uncertainty
bull Risk can be priced by financial markets because it depends on known distribution of events to which investors assign probabilities and price things accordingly
bull Uncertainty on the other hand canrsquot be priced it relates to events conditions and possibilities that canrsquot be predicted measured or modeled
Frank HKnight 1921
6
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Events and Uncertainty
bull Risk can be priced by financial markets because it depends on known distribution of events to which investors assign probabilities and price things accordingly
bull Uncertainty on the other hand canrsquot be priced it relates to events conditions and possibilities that canrsquot be predicted measured or modeled
Frank HKnight 1921
6
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
BASEL II Pillar II ICAPP Banksrsquo responsibilities
a) Banks should have in place a process for assessing their overall capital adequacy in relation to their risk profile
and a strategy for maintaining their capital levels (Principle 1)
b) Banks should operate above the minimum regulatory capital ratios
(Principle 3)
7
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk Based Supervision
Risk Based Supervision (RBS) which focuses on evaluating both present and future risks identifying
incipient problems and facilitates prompt intervention early corrective action should be the approach
for bank supervision as against the present compliance-based and transaction testing approach (CAMELS)
which is more in the nature of a point in time assessment RBS benefits the bank supervisor by optimizing
its use of supervisory resources and also helps the regulated entities in improving their risk management
systems oversight and controls
8
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Business risk vs Consequential risk
Legal risk Liquidity Risk
Settlement Risk Operational Risk
Credit and Market Risk
9
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk Dimensions of Balance sheet components
10
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk dimensions of Balance Sheet
L A Components Risks R
Owned Funds bull Foreign cy Exchange R
Borrowed Funds Assets bull Different maturity Liquidity R
bull Different market segment
bull Different credit Credit R
bull Different country
bull Different pricing Interest R
Processes Acctng Tech settlement etc
Operational R
bull Different regulations Other R
bull Different legal systems
11
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Market Risk
12
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Understanding Market Risk
It is the risk that the value of on and off-balance sheet positions of a financial
institution will be adversely affected by movements in market rates or prices such as interest rates foreign exchange rates equity
prices credit spreads andor commodity prices resulting in a loss to earnings and
capital
13
bull
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Convergence of Economies
Easy and faster flow of information Skill Enhancement
Increasing Market activity
Increased Volatility Need for measuring and managing Market Risks Regulatory focus Profiting from Risk
14
Leads To
Why Market Risk very Sensitive
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Foreign Exchange Risk
Incurring losses due to change in exchange rates Variation in rates impacting the value
of assets and liabilities or revenues and expenses
15
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Interest Rate Risk hellip
bull The amount at risk arising out of the magnitude and direction of interest rate changes
Repricing Risk
Basis Risk
Yield Curve Risk
Embedded Option Risk
16
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Market Risk and linkages
Business Model Risk Credit Risk Liquidity Risk
Operational Risk Legal Risk
17
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Business Model Risk
MF Global 45 bio Euro
The spread between interest earned and the financing cost of the underlying repurchase agreement has often been attractive even as
the structure of the transaction themselves essentially eliminates market and financing riskrdquo------- Jon Corzine
A brokerage firm Changed to a tradinghedge fund
Managed by the Chief Himself directly
1
18
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Credit Risk
The derivative products sold to the end users
19
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Liquidity Risk Continental Illinois
20
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Operational Risk
ING Bank UBS
21
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Legal Risk
Procter amp Gamble
22
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Classification of market risks
Instrument type Rates Category Forex Category
Spot Instruments No risk Forex spot risk
Forward instruments (base risks) Curve risk Spread risk Specific risk Volatility risk
Yield risk (currency 1) Yields risk (currency 2) Volatility risk
Option instruments (uncertainty of exercise)
Embedded option risk Embedded option risk
23
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Common Instruments to managehellip
Exchange Risk
Interest Rate Risk
1 Forward Cover
FRA
2 Futures
Swaps
3 Currency Option
Option
4 Variance of this
Variance
24
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk Management involves
Identifying
Measuring
Monitoring
And Managing
25
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk Measurement
Methodologies
26
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Development of Risk Methodologies
4 Economic Capital
3 Value-at-risk
2 Exposures sensitivities
1 Nominal based calculations
Increasing sophistication
27
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Five reasons why market risk measurement is important
1 Management Information 2 Setting Limits
3 Resource Allocation 4 Performance Evaluation
5 Regulation
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
29
Evolution of Analytical Risk Management tools
1938 Bond duration
1952 Markowitz mean variance framework
1963 Beta (CAPM Model)
1966 Multiple factor models
1973 Black Scholes Greeks
1983 Risk adjusted return on capital
1986 Limits on exposure by duration
1988 Limits on Greeks
1992 Stress testing
1993 Value-at-Risk
1994 Risk Metrics
1997 Credit Metrics
1998 Integration of credit amp market risk
2000 Enterprise wide risk management 29
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
VaR 1048708 Pioneered by major US banks in the rsquo90s as
derivatives developed
1048708 Defined as the predicted worst-case loss at a
specific
confidence level over a certain period of time
1048708 Adopted by all major financial institutions ndash
cornerstone of day-to-day market risk
measurement
1048708 Usage of VaR as the risk measurement
Across different markets and products
Across different time periods
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Value-at-Risk
Value-at-Risk is a measure of Market Risk which measures the
maximum loss in the market value of a portfolio with a given
confidence
VaR is denominated in units of a currency or as a percentage of
portfolioholdings
For eg a set of portfolio having a current value of say Rs100000-
can be described to have a daily value at risk of Rs 5000- at a 99
confidence level which means there is a 1100 chance of the loss
exceeding Rs 5000- considering no great paradigm shifts in the
underlyingfactors
It is a probability of occurrence and hence is a statistical measure of
riskexposure
31
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
VaR Models
(a) Parametric Risk Metrics ( GARCH ) (b) Nonparametric ( Historical simulation and Hybrid Model)
( c) Semi parametric model ( Extreme value theory conditional
autoregressive VaR)
32
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
VAR answers a risk measurement question (not a risk management question)
ldquohow much can we lose in a given time frame with a specified confidence levelrdquo
The VAR question needs two specifications to be asked a time horizon
and a confidence level You can look at the same portfolio and ask for
example ldquoWhat is the VAR with 95 confidence over one yearrdquo or
ldquoWhat is the VAR with 99 confidence over one dayrdquo
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
The following assumptions underlie the VAR calculation
bull Stationary the (shape of the) probability distribution is constant over time
bull Random tomorrowrsquos outcome is independent of todayrsquos outcome
bull Non-negative requirement assets cannot have negative value
bull Time consistent what is true for a single period is true for multiple periods
eg assumptions about a single week can be extended to a year
bull Normal expected returns follow a normal distribution
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Limitations of VaR
1048708 Fundamental assumption that future risk
can be
predicted from historical distribution
1048708 Vulnerable to regime shifts amp sudden
changes in
market behavior
1048708 Makes assumption and subjective
judgment for risk
factorsrsquo volatility amp correlation
1048708 VaR calculated by different methods
have different
limitations
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
It should also be noted that VaR only measures quantifiable risks it
cannot measure risks such as liquidity risk political risk or
regulatory risk
36
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk Mangement Facts
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk management does not envisage compromising
profitability with long term sustainability
38
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
It is a discipline at the core of every financial institution and encompasses all the activities
that affect its risk profile
39
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
bull RISK BY CHOICE AND NOT BY CHANCE
bull INTEGRATED NOT FRAGMENTED APPROACH (ASSET LIABILITY OFF-BALANCE SHEET ITEMS)
bull INTEGRATED APPROACH TO MARKET AND CREDIT RISKS
40
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
Risk Management is a discipline at the core of every financial institution
and encompasses all the activities that affect its risk profile
41
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42
An Approach
bull What is the product
bull Hedging or tradingproprietary
bull Risk assessment
bull Loss limitations
bull Monitoring
bull Triggers to adhere to risk mitigation
rules in place
42