The post White paper: Margining and Collateral as CCR Mitigation Tools appeared first on PrevioRisk.

]]>Download

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]]>The post White paper: Netting in CCR appeared first on PrevioRisk.

]]>The paper presents brief summary of netting principles and effects in Counterparty Credit Risk. We discuss advantages, types of netting and main concepts for institutions with derivative portfolios.

From the practical point of view, we first implement concept of netting with simple examples and then show netting effects for simulated portfolios of derivative transactions. In addition to collateral and margining, netting is one of main methods of CCR mitigation.

The full text of white paper is available at our Research Papers page. You can also download it by the link below:

Download

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]]>The post BCBS Publishes Finalized Margin Requirements for Non-Centrally Cleared Derivatives appeared first on PrevioRisk.

]]>According to the document, non-centrally cleared derivative trades will be subject to initial and variation margin, in order to mitigate the inherent counterparty risk. The framework has been designed to reduce systemic risks related to over-the-counter (OTC) derivatives markets, as well as to provide firms with appropriate incentives for central clearing while managing the overall liquidity impact of the requirements.

Compared with the near-final framework proposed earlier this year, the final document exempts some deal types from initial margin requirements (such as physically settled FX forwards and swaps). Also, it permits “one-time” re-hypothecation of initial margin collateral among the features to mitigate the liquidity impact associated with the requirements.

The implementation will be spanned over a four-year period, with a first milestone on 1st December 2015.

Full text of the document is available at http://www.bis.org/publ/bcbs261.pdf

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]]>The post White paper: Basel Capital Requirements for Portfolio of Derivatives appeared first on PrevioRisk.

]]>The results of practical implementation show that Internal Model Method of EAD estimation produces about a quarter (27-28%) lower CCR capital charge than Standardized and NIMM methods. Particularly, IMM allows to recognize fully the effect of netting and margining, and saves capital for trades influenced by market factors with low volatility. In addition, the results confirmed that IRB risk weighting approach results in lower required capital estimates than the Standardized one, with capital relief from IRB implementation reaching 35-40%.

The full text of white paper is available at our Research Papers page. You can also download it by the link below:

Download

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]]>The post Basel III CVA Capital Decomposition appeared first on PrevioRisk.

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As was mentioned above, this is formula for Standardized CVA capital charge calculated at portfolio level, which in the given form does not allow to define main drivers and components of CVA capital charge. For this purpose we use decomposition, based on EAD on customer or even trade level. As we will see, it is possible to manage portfolio by hedging separate trades. Here is the example of CVA capital decomposition for portfolio of 250 derivatives with total notional of 4.5 bln (all numbers are in USD mln).

To decompose across customers (or trades), we use the derivative of with respect to trade level EAD. For the case without hedges, it can be represented as:

where .

Thus, counterparty-level capital charge for i-th counterparty is defined as:

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]]>The post Using Sensitivities to Forecast Portfolio PV appeared first on PrevioRisk.

]]>However, we can define risk factor, which has the highest expected impact on Present Value.

This can be illustrated by an example of FX Forward for EUR (settlement currency is USD) , Notional = 1,000,000 EUR, Forward USD/EUR rate is 1.3075 with Maturity = 2 years. Present Value of plain FX Forward for Euro has positive sensitivity to EUR/USD exchange rate (assuming that portfolio base currency is USD) and negative — to discounting interest rates for USD. Present Value of position increases if EUR appreciates — a contract to buy EUR under fixed rate (forward rate) would give its holder higher payoff. Similarly, if interest rate for USD increases, then future payoff is discounted by higher rate and, thus, Present Value decreases.

Note that Delta Equivalents are yield sensitivities for interest rates, and price sensitivities for exchange rates. Sensitivity column displays Present Value change for 1 bp change of underlying. See Yield and Price Sensitivity post for details about yield sensitivities.

Sensitivities presented above, however, do not allow to define expected change of Present Value for given time horizon. Let’s first try to understand what is the expected PV change for 1-month horizon across 5 groups of market factors: Interest Rates, Exchange Rates, Credit Spreads, Commodity and Equity Prices. Below we show simulation results for portfolio of 261 trades with following structure:

DeltaPV is total expected PV change, assuming that underlying market factors will have same dynamics as during 3-year period. As we can see, the portfolio is most sensitive to FX exchange rates. Expected PV change for 1-month horizon, however, is significantly lower, as volatility of currency prices is very low.

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]]>The post What Is: N-Cap and N-Floor appeared first on PrevioRisk.

]]>Double Strike Floor and Double Strike Cap (N-Floor and N-Cap) are modifications of the Interest Rate Floor/Cap. In a Knock-Out Floor/Cap, once the trigger rate is breached (Knock-Out or KO event), the protection of the Floor disappears for that period. In a Knock-In Floor/Cap, protection does not appear unless the trigger is breached (Knock-In or KI event). Here are examples of payoff profiles for Double Strike Floor and Cap.

Multiple strike derivatives give additional option once first strike (trigger) is traded. With an N-Floor, once the trigger is reached the original floor level is replaced with new floor level for that period. That makes the contract more risk averse than simple Floor with barrier. As payoff for double strike products is smaller at some positions of interest rate that makes them significantly cheaper.

As can be seen from the figure below, DS Cap can protect investor from significant increase of interest rates muck better that simple Cap. Dual Strike Floor, similarly, has higher limit for potential losses from significant interest rate decrease. The price of this protection is first barrier which “clears” memory of instrument in case of high market volatility.

For example, let’s consider investor who has a 3-years floating rate asset with payoff based on LIBOR. While investor believe that LIBOR will stay high and potentially increase further, he wants some interest rate protection. Investor can purchase 0.6% Floor for 225 basis points. Alternatively, he can enter Double Strike Floor as follows: 3-year 0.6% floor, trigger at 0.5%, and second floor level at 0.4%. In this case investor would have 0.6% floor unless interest rate is between 0.5% and 0.6%, and if rate is below 0.5% then floor is replaced with new 0.4% cap for that period. The cost of second option would be approximately twice lower.

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]]>The post PrevioRisk. A counterparty credit risk management system. appeared first on PrevioRisk.

]]>Compono Strategia, a credit risk services provider, has leveraged risk analytics from RiskMetrics, an MSCI brand. These analytics will deliver an integrated framework for counterparty credit risk management through the PrevioRisk platform for banks, brokers and corporates in the Middle East.

Uzma Naeem Ikram, Director Compono Strategia, says: “Banks, corporates and financial institutions will benefit from the integration of PrevioRisk’s power in fully configurable rule and aggregation functionality, with the best-of-breed risk and stress testing capabilities provided by RiskMetrics Web Services. Sell-side traders and risk managers will benefit from the ability of PrevioRisk’s technology to support all margin models and asset types, with the flexibility to respond dynamically to client needs and market events. Clients will gain greater control and transparency from enhanced reporting though the replication of counterparty methodologies and seamless integration of analysis and data.”

Robert Ansari, Head of Coverage for the Middle East, MSCI, adds: “Given the forthcoming implementation of the Basel III guidelines, the risk measurement and management of bilateral and central counterparty (CCP) agreements has become a greater area of focus for our clients globally. RiskMetrics counterparty credit risk analytics are evolving to help our clients become more compliant with their internal and regulatory requirements. We are delighted that Compono Strategia has chosen to utilize our analytics, allowing PrevioRisk platform users to receive intraday risk and exposure analysis, which will then drive the generation of reports on-demand across multiple asset classes.”

Key benefits of the offering include: Counterparty Credit Exposure, CVA, client-specific stress scenario based margining; what-if-scenarios; combined risk and margin rule-based exposure analyses.

For further information on PrevioRisk, please visit their web site at www.previorisk.com

For further information on MSCI, please visit our web site at www.msci.com

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]]>The post Risk Versus Uncertainty appeared first on PrevioRisk.

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Risk:We don’t know what will happen in future, but we do know the distribution of future outcomes.

Uncertainty:We don’t know what will happen in future, and we don’t know what the possible outcome distribution is.

In other words, the future is always unknown — but that does not make it “uncertain.”

Although the definitions we have just provided are very simple, they can explain a lot when going into details.

“Damage or loss” in the definition of risk means that a spectator does realize that observable process or event may lead to negative effect. Note that it is not necessary to measure the size of this effect to realize the fact that it may occur. “Chance” means that the spectator possesses certain information, which allows describing the cause-effect relationship in any formal way. Still, this does not mean that he is able to predict future. The spectator can only define all possible outcomes of the process. Future is unknown, but certain. The latter is a key word in the definition of risk.

There is also a more formal way to define the terms of risk and uncertainty.

Assume that any process can be described by set of outcomes . In case you have no information about this process, is the same as universal set of all possible outcomes: .

Assume now that you have any information or data , which allows you guessing about the subset of future outcomes. Thus, conditional set of future outcomes is a subset of universal set, conditioned on : . Future is still unknown; however, you may guess about possible outcomes for different processes i and j:

,

.

This is how definitions of risk and uncertainty can be formalized.

Institutions can reduce uncertainty by researching their processes. For example, a bank can reduce its credit uncertainty by getting to know its borrowers. A brokerage firm can reduce market uncertainty by obtaining more knowledge about the markets it operates in.

As for the risk, there are two types of action which can be applied to decrease its negative effect: risk can be managed or reduced.

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]]>The post Fake News — New Type of Financial Risk? appeared first on PrevioRisk.

]]>The S&P 500 was up about 1 percent at about 1,578 at 1:07 p.m. New York time today when a posting on the Associated Press Twitter account said there had been explosions at the White House and President Barack Obama had been injured. The benchmark gauge for American stocks erased almost the entire gain, falling as low as 1,563.03 by 1:10 p.m.

Lu Wang, Whitney Kisling and Eric Lam, Bloomberg – Wednesday, April 24, 2013

Can this event be estimated using standard stress-testing approach? Probably, yes. Existing methodologies succeeded.

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