1. Market Risk

2. Risks Faced by Financial Intermediaries
Credit Risk
Liquidity Risk
Interest Rate Risk
Market Risk
Off-Balance-Sheet Risk
Foreign Exchange Risk
Country or Sovereign Risk
Technology Risk
Operational Risk
Insolvency Risk

3. Market Risk:
Market risk is the uncertainty resulting from changes in market prices . It can be measured over periods as short as one day.
Usually measured in terms of dollar exposure amount or as a relative amount against some benchmark.

5. Market Risk Measurement
Important in terms of:
Management information
Setting limits
Resource allocation (risk/return tradeoff)
Performance evaluation
Regulation (internal model)

6. Calculating Market Risk Exposure
Estimate potential loss under adverse circumstances.
Three major approaches of measurement
JPM RiskMetrics (or variance/covariance approach)
Historic or Back Simulation
Monte Carlo Simulation

7. JP Morgan RiskMetrics Model
DEAR = ($position)(price sensitivity)
(potential adverse move in yield)
= ($position)(price volatility)
VAR = DEAR

8. Risk Metrics:Fixed-Income Security
Daily Price Volatility = (MD)(adverse daily yield move)
MD* = = dR

9. Risk Metrics:Fixed-Income Security

10. Risk Metrics:Foreign Exchange
DEAR = ($FX position)(price volatility)
cx. spot FX=swf 1.6M, spot rate=$0.625/swf
of spot rate=56.5 bp

11. Risk Metrics:Equity
σit2=βit2σmt2+σeit2

12. Risk Metrics:Portfolio Aggregation

15. Historic or Back Simulation
Advantages:
Simplicity
Does not require normal distribution of returns
Does not need correlations or standard deviations of individual asset returns.

16. Historic or Back Simulation
Basic idea: Revalue portfolio based on actual prices (returns) on the assets that existed yesterday, the day before, etc. (usually previous 500 days).
Then calculate 5% worst-case (25th lowest value of 500 days) outcomes.
Only 5% of the outcomes were lower.

18. Historic Simulation :Weaknesses
500 observations is not very many from statistical standpoint.
Increasing number of observations by going back further in time is not desirable.
Could weight recent observations more heavily and go further back.

19. Monte Carlo Simulation Approach
To overcome problem of limited number of observations, synthesize additional observations.
Perhaps 10,000 real and synthetic observations.
Employ historic covariance matrix and random number generator to synthesize observations.
Objective is to replicate the distribution of observed outcomes with synthetic data.

20. Regulatory Models BIS Standerdized Framework
BIS (including Federal Reserve) approach:
Market risk may be calculated using standard BIS model.
Specific risk charge.
General market risk charge.
Offsets.
Subject to regulatory permission, large banks may be allowed to use their internal models as the basis for determining capital requirements.

21. BIS:固定收益交易部位

24. BIS:外匯交易部位
換成本國貨幣後
必要資本 = 8 %  max{|long|, |short|}

26. 股票部位
必要資本 = X Factor + y Factor =

27. Large Bank:BIS vs.Internal Models
Problems of 1993 BIS framework for measuring mkt risk
 not accurate teniques
 failed to encourage diversification
 incompatible with large bank internal systems

28. Large Banks: BIS versus RiskMetrics
In calculating DEAR, adverse change in rates defined as 99th percentile (rather than 95th under RiskMetrics)
Minimum holding period is 10 days (means that RiskMetrics’ daily DEAR multiplied by 10.
Capital charge will be higher of:
Previous day’s VAR (ie. DEAR  10)
Average Daily VAR over previous 60 days times a multiplication factor  3.