Trading Book Risk Management: Stressed VaR, Exp. Shortfall, Incremental Risk Charge & CVA

2 days
Prague, NH Hotel Prague
  • Developments in Regulatory Trading Book Treatment
  • Value-at-Risk and Its Shortcomings
  • Calculating and Interpreting Stressed VaR
  • VaR, Liquidity Horizons and Liquidity Risk
  • The Incremental Risk Charge and the Comprehensive Risk Measure
  • Using CVA, DVA and FVA in Pricing
  • Calculating the CVA Risk Charge
  • The Impacts of the New Rules on Banks' Business Models
A two-day course on methods and changing regulatory requirements for measuring and managing market and spread risks in the trading book

The purpose of this seminar is to give you an overview and a good understanding of the new measures that were introduced with "Basel 2.5" and of the measures which are expected to be introduced as a part of Basel III and those that are expected to follow in the coming years from the recommendations in the Basel Committees "Trading Book Review".

We start with an overview of regulatory developments since 1995. We explain the measure of Value-a-Risk and we discuss its advantages and shortcomings, including the problems with illiquidity and lack of coherence. We then thoroughly explain the measures introduced in the so-called "Basel 2.5" framework to address these weaknesses: Stressed VaR, Incremental Risk Charge and the Comprehensive Risk Measure for securitization transactions. We explain the concept of "liquidity horizons" and we demonstrate how the calculations are performed translated into capital charges. Further, we discuss the proposed treatment of hedging and diversification in the trading book and of the revised internal risk models based approach and the revised standardized (partial risk factor) approach.

We then look at the changes suggested in the updated "Fundamental Trading Book Review", in particular the proposed switch from VaR to "Expected Shortfall" (ES). We explain why ES is, in theory, a better (more coherent) risk measure than VaR. We show how ES is calculated, how ES expectedly will translate into capital charges, and how ES and other risk measures are used in practical trading book risk management. We also discuss the practical difficulties in back testing ES model and suggest possible solutions to these problems.

Further, we look into the new CVA risk capital charge, which came into effect in January, 2013. We explain how the CVA risk capital charge is calculated according to standardized and advanced methods under the Basel III rules. We also explain the similarities and differences between the related concepts CVA, DVA and FVA and demonstrate how they are using in pricing of derivatives.

Finally, we discuss the possible consequences of these changes in the regulatory treatment of the trading book for banks' business models, costs structure and profitability.

09.15 - 12.00 Developments in Regulatory Trading Book Treatment

  • From Basel I to Basel III via Basel II and 2.5
  • The Market Risk Amendment
  • Basel 2.5
  • The Updated Fundamental Trading Book Review
  • Possible Bank and Market Implications

Value-at-Risk and Its Shortcomings

  • Definitions of VaR
  • Ways of Calculating VaR
  • Capital Charges Based Upon VaR
  • Examples of VaR Calculations
  • Problems with VaR
    • Illiquidity
    • Non-comprehensive (non-subadditivity)
  • Case Studies:
    • Failure of VaR to capture risk during the Lehman crisis
    • Failure of VaR to capture risk at JP Morgan
  • Small Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 New Risk Measures Under Basel 2.5

  • Calculating and Interpreting Stressed VaR
    • Stressed VaR definition and scope
    • Identification and validation of the stressed period
    • Review of the stressed period
    • Stressed VaR methodology
    • Calculating the capital charge with stressed VaR
    • Example and exercise
  • The Incremental Risk Charge
    • Definition
    • Modelling default
    • Modelling migration
    • Results and capital charge
    • Example and exercise
  • The Comprehensive Risk Charge
    • Definition
    • Modelling choices
    • Results and capital charge
    • Example and exercise

Day Two

09.00 - 09.15 Brief recap

09.15 - 12.00 The Proposed Changes to the Trading Book

  • Trading Book/Banking Book Boundaries
  • New Risk Metric: Expected Shortfall
  • Stressed Calibration
  • Assigning Liquidity Horizons
  • Treatment of Hedging and Diversification
  • Revised Internal Risk Models Based Approach
  • Revised Standardized (Partial Risk Factor) Approach
  • Examples and Small Exercises

A Closer Look at Expected Shortfall as a Tool for Financial Risk Management

  • Expected Shortfall - Definition
  • Expected Shortfall As a Coherent Measures of Risk
  • Parametric Estimation of ES
  • Nonparametric Estimation of Expected Shortfall
  • Proposed Use of ES As a Regulatory Risk Measure
  • Backtesting ES Model Challenges and Solutions
  • Uses of ES in Bank Risk Management and Asset Allocation
  • Examples and Exercises

12.00 - 13.00 Lunch

13.00 - 16.30 Credit Value Adjustment, Debt Value Adjustment and FVA

  • Introduction
  • Two Ways of Looking at Counterparty Risk
    • Pricing
    • Risk management
  • Two Standard Metrics of Counterparty Risk
    • PFE profiles
    • EPE profiles
  • CVA Definition and Calculation
  • DVA Definition and Calculation
  • FVA vs. DVA
  • Use of CVA and DVA in Valuation (Pricing)
  • Calculating the CVA Risk Charge
    • Standardized method
    • Advanced method
  • Examples and Exercises

Evaluation and Termination of the Seminar

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