Market Risk & Liquidity
Management
Jawwad Farid
alchemya.com
FinanceTrainingCourse.com
[email protected]
Agenda
Introductions
Challenges
Market Risk
Questions
Wrap up
Jawwad Intro
• Fellow Society of Actuaries, Investments
• MBA, Columbia Business School
• 21 years consulting: US, UK, MENA, Africa,
Pakistan & Far East.
• Risk Management, Product Development,
Regulatory Reporting, Actuarial Practice
• Prefers - Jawwad - (Pronounced Javaad)
http://FinanceTrainingCourse.com
http://www.alchemya.com
[email protected] 3
Models at work
Market Risk
Why is risk broken?
A survey of opinions
The governance structure is broken.
Market Risk and Middle Office function is dysfunctional.
The separation between Risk and business is not
working.
The best risk managers come from business.
More opinions on risk
Risk is a dead end job. Can’t attract the right talent.
Is volatility the right measure?
Risk is the stupid trade that should have never
happened.
Pre-Trade limit enforcement.
From hot to dead end.
Risk is broken.
Risk is a dead end job.
2014
Risk is hot.
Risk models are
2007
hot. Pricing models rule.
1996-
2000
Top Questions
What drives the
Why is risk distrust towards
broken? risk in board
rooms?
What can we do to
fix it?
Why is risk broken?
Non Models vs. Reconciling
Integrative Applications Decoding Risk and
Risk vs. Volatility Financial
Management Interpretation systems.
• Gap between • Reporting lines
practice and • Backseat driving
theory • Talent
• Validation of management
models
Real World
Governance
Models
Single Tracking
Source Data Volatility
• Reconciling data • Unstable
with financial correlations
source systems. • Cyclical volatility
• Credibility issues
Capital & Distribution
Then
Distribution of Portfolio Value
Critical Expected
Barrier Value
Em ergency Norm al
Managem ent Operating
Conditions Conditions
Frequency
Econom ic
Capital
50 70 90 110 130 150
Now Portfolio Value
Capital & Distribution
Regulator,
Shareholders
Depositors,
Counterparties, Distribution of Portfolio Value
Critical Expected
Barrier Value
Em ergency Norm al
Managem ent Operating
Rating Agencies
Conditions Conditions
Frequency
Econom ic
Capital
50 70 90 110 130 150
Portfolio Value
Real world models
Why is risk broken?
Thought experiment - One
Correlations
Distribution & Correlations
Correlations
The right blend - correlations
Crude Oil Blends - Prices
120
105
90
75
Brent Abu Dhabi- Murban Dubai- Fateh Iran-Heavy Saudi Arabia- Light
Correlation Abu Dhabi- Murban with Brent
1.00
0.60
0.20
(0.20)
(0.60)
(1.00)
Abu Dhabi- Murban with Brent
Correlation - Saudi Arabia- Light with Brent
1.00
0.60
0.20
(0.20)
(0.60)
(1.00)
Thought experiments- Two
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Interest Rates - Volatility
12%
8%
4%
0%
15/03/2008 08/07/2008 31/10/2008 23/02/2009 18/06/2009
7 Days 14 Days 1 Month 3 Months
FX Rates - most
AUD-JPY Sterling-JPY USD-AUD EUR-JPY
3.6%
2.8%
2.0%
1.2%
0.4%
13/03/08 09/06/08 05/09/08 02/12/08 28/02/09 27/05/09
FX Rates - least
USD-JPY USD-EUR Sterling-EUR EUR-CHF
1.4%
1.2%
1.0%
0.8%
0.6%
0.4%
0.2%
13/03/08 09/06/08 05/09/08 02/12/08 28/02/09 27/05/09
FX Rates Volatility – Emerging
Markets
2.4%
1.6%
0.8%
0.0%
19/03/2003 29/03/2004 09/04/2005 20/04/2006 01/05/2007 11/05/2008 22/05/2009
Euro Sterling Japanese Yen US Dollar
Canadian Dollar Swiss Frank Australian Dollar
Tracking volatility
Trailing volatility & correlations
Trailing Vol - Trends
0.1
0.1
0.1
0.1
0.1
0.0
0.0
0.0
0.0
-
5-Jan-04 5-Jan-05 5-Jan-06 5-Jan-07 5-Jan-08 5-Jan-09 5-Jan-10 5-Jan-11 5-Jan-12
WTI_Volatility EUR_Volatility Gold_Volatility Silver_Volatility
Volatility - Distribution
Governance Structure
The Framework
Marginal
Exposure Trend Capital
Impact
Connections
Price Risk Value
Products Limits
Price
Volatility
Models
Relative Value
Relative Value - II
40
Transaction & Exposure Limits
Within a Trade • Max Ticket size
Within a security • Max Product limit
Within an operating cycle • Max Daily limits
Within a tenor or maturity
• Max Tenor Exposure
bucket
Within a risk classification
• Max Ticket Size
or grade
Sensitivity Limits
• Change in USD Equivalent Exposure
To Exchange Rates • Change in Position value per PiP
To Interest Rates • Duration, PVBP, Gaps, Interest Rate Mismatch
To Volatility • Vega, Change in value, Change in projected P&L, Gamma
• Change in projected earning, Net Interest Income or Earnings
Earnings at Risk
Shareholder Value • Change in Income, Market Value of Equity or NPV
Equity or Capital • Maximum Loss, Impact of ALM choices on Capital
Limit Management
Sensitivity Limit
limits Management
Exposure Counterparty
Limits Limits
Transaction
Limits
Governance
Reporting
Business Risk
Lines
Looking up,
Conflicts
at or down?
Products & Payoffs
Limits
Reconciliation
Single Source of data
Volatility
Approaching volatility
Monthly Crude Oil Change
Crude oil price changes - daily
250 120.00%
100.00%
200
80.00%
150
60.00%
100
40.00%
50
20.00%
0 0.00%
Frequency Cumulative %
Volatility - Distribution
Gold
Oil
Silver
EUR-USD
More Thought experiments
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Model price vs. Market price vs.
liquidity
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Swap Points - A
Swap Points - B
Swap Points - C
Swap Points - D
Swap Points - E
Four relationships
(1 rlocal) /(1 r $) E(1 ilocal) / E(1 i$)
Interest Rate Expected Inflation
Differential Rate Differential
( forwardlocal / $) /(Spotlocal / $)
Forward &
E(Spotlocal / $) /(Spotlocal / $)
Expected change in
Spot spot rates
Differential
Thought Experiement
Is Gold safe now?
Is Gold safe now?
Bubble and after
What is Risk?
A framework for risk management
Four Questions
Marginal Capital /
Exposure Trend
Impact Appetite
Exposure
2,000
1,500
1,000
500
0
Lease Finance Long Term Short Term Finance Medium Term
Trend
300
250
200
150
100
50
0
1 2 3 4 5 6 7 8 9 10 11 12
February March April May June
Exposure, Risk, Target Accounts
Exposures Risk Target Accounts
• Gross • Probability • Sit
Numbers that we may somewhere
• Book Size lose in the middle
• Driven by something at the
Internal • Driven by intersection
choices external of exposure
factors and risk
What is exposure?
Volatile
Financial
Uncertain
Impact
Exposure
What is a Target Account?
Measurable/ Sensitive/ Explainable/
Reportable Relevant Understandable
Exposure, Risk, Target Accounts
Exposures Risk Target Accounts
• Gross • Probability • Sit
Numbers that we may somewhere
• Book Size lose in the middle
• Driven by something at the
Internal • Driven by intersection
choices external of exposure
factors and risk
Target Accounts & Impact
P&L
Risk &
Capital
Benchmark
Governance revisited
Governance challenges
Who is the regulator?
• Central Bank, Securities regulator
Local • FMA & ACI Code of conduct
• OCC, Federal Reserve, FSA
International • North American and EU regulations
• Broadest definition.
Morality • How do you teach morality to smart people?
The Gambit – Rational thinking
Expected Payoff > Penalty
Expected Payoff < Penalty
In an imperfect world?
• Impact
Social Costs • Group behavior
• Recognition
Personal Costs • The desire to get caught
The cost of • Direct
being caught • In Direct
Regulatory • Paradigm shift
compensation • Make an example – The bite & teeth
Cases & Messages
Misrepresentation • The slide in security prices
Collusion
• FSA Libor Crisis, FX
Exchange rate crisis
Client • Front Running, Insider
Confidentiality Trading, Gouging
Consequence
Bank wide • Fines, penalties
• Loss of license
impact • Civil Suit, Class Action Suit
• Suspension & Termination
Management • Negative lists
• Future prospects
• Suspension & Termination
Dealers • Negative lists
Q&A
Alchemy Intro
• Actuarial & Risk Advisory firm
• 11 years, 4 Markets
• Banking and Insurance Risk, Capital Adequacy Focus
• Derivative & Risk Management models, Treasury Management
• ALM, ICAAP, Stress Testing, Financial Product Development
• More than 3,000 trained participants across 150 workshops
FinanceTrainingCourse.com
Jawwad Ahmed Farid
alchemya.com
FinanceTrainingCourse.com
[email protected]
