A generic methodology for quantifying model risk, and more specifically estimation risk, is proposed. The choice of sample size, distribution tail heaviness and percentile to be estimated all have a material impact on the quantum of estimation risk.  Aggregate estimation risk across a portfolio of models reduces materially – similar to a diversification benefit. Extreme quantiles are more likely to be over-estimated than under-estimated. Model-error over-estimation is unbounded.

The surge of supervisory stress-testing that began after the 2007–08 financial crisis had a clear purpose: to identify banks in danger of imminent distress and reassure the market that those still standing were solvent and could survive the downturn.

More than a decade later, issuance costs for bank debt could hardly be lower – even for subordinated bonds. That suggests a level of confidence among investors that they understand the risks in the banking sector. However, bankers say the data demands from regulatory stress-testing are, if anything, becoming more intense. 

Increasingly, regulators seem to see the stress-testing exercise more as a way to identify process failures rather than balance sheet risks. And banks see them as a capital constraint that is misaligned with the Basel risk-based ratios, or even just as an extra layer of bureaucracy. The annual round of...

MarketAxess, an electronic beast in the US corporate bond market, says it processes about one-fifth of the investment-grade segment, and it’s in the midst of a growth spurt. The company is also hoping to make inroads to the colossal US Treasury market soon. 

And Oliver Huggins, who joined in April, is its chief risk officer.

Its first.

Huggins, who began his career in exotic interest-rate structuring, was hired to build a risk structure, something he first did almost a decade ago at UK

Investing according to environmental, social and governance (ESG) criteria can be done in various ways, with continuing development of filters and ways of analysing companies. As the market in ESG indexes and investments linked to sustainability matures,…

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The interconnectedness of a bank is highly significant to its systemic risk. The systemic risk of China’s banking sector is higher in 2007, 2008, 2011 and 2012. The risk contribution of small banks increase significantly when systemic risk is high.

A long-simmering debate in the clearing world on who should swallow losses that have nothing to do with defaults received a jolt as two US clearers proposed ways of divvying up part of those costs among their members.

On August 21, Options Clearing Corporation (OCC) filed for a rule change that would distribute part of operational losses – cyber, fraud, theft and others – to its members. The very next day, Ice Clear Credit (ICC) went in a completely different direction: it filed to have its

When an investment fund starts to have liquidity issues, the problem can magnify rapidly. What starts as a dry patch can soon become a forest fire, as this summer’s run on Woodford illustrated. When the firm gated its flagship equity income fund in June, preventing investors from redeeming, selling or transferring shares, it thrust liquidity stress-testing into the limelight. Months later, the fund is still closed for investing or redemptions, as managers try to reposition from illiquid

Correlation among different assets is an important factor in determining margin charges to members relating to the portfolios presented for clearing at CCPs. There are limitations to the use of overly simplified correlation assumptions in CCP margin models. The first motivation of this research is to apply and understand time-varying, conditional correlation for a representative margin model to isolate the effect of correlation risk. The second motivation is to understand how sensitive various portfolios are to correlation shocks and identify tools available to mitigate correlation risk. The research indicates it may be prudent to account for correlation dynamics when calculating margin at CCPs.

In static risk capital allocation problems with Value-at-Risk, the Euler rule is very volatile. In dynamic applications, the Euler rule is also very sensitive to measurement error. These findings also hold for Expected Shortfall, but are less pronounced. A solution is to first fit a given distribution, and then allocate risk capital theoretically.

The link between sustainable business practices and financial performance is hotly debated. 

There is plenty of anecdotal evidence of companies with poor environmental, social and governance (ESG) records – Volkswagen and PG&E, for example – coming a cropper. But establishing a clear statistical correlation between ESG scores and stock returns has proven difficult.

In bond markets, the data is more conclusive. 

Credit Benchmark analysed the credit performance of global companies with high and low ESG scores. When credit conditions were deteriorating in the first half of 2016, companies with low ESG scores fared especially poorly – with credit risk increasing by nearly 20%. This compares with a 4.5% increase in credit risk for companies with high ESG scores.  

Low ESG companies bounced back strongly after credit trends turned positive in mid-2016, with credit risk among this group dropping by 25% over the past three years....

This paper introduces a consistent performance strategy (CPS), which, if followed, leads to a portfolio having consistently positive returns over time and exhibiting a steady upward trend. This strategy is inspired by moving average trading rules in classical technical analysis and is shown to be optimal in a modern dynamic portfolio choice framework. We illustrate our strategy via both simulation (model) and walk- forward testing (market data).

 

 

 

 

 

 

 

How banks game stress tests: the ‘shocking’ truth

Leaked memo exposes effort to swap out risky assets despite Fed’s push to end “window dressing”

IFRS 9 flings loan-loss provisions haphazardly higher

Under the standard, cash piles for bad loans were expected to ramble. Just not quite so much

Synthetic Libor mooted as ‘tough legacy’ fix

Recalibration of doomed rate or catch-all legislation under debate as lifeline for lingering contracts

 

COMMENTARY: Capital punishment

Two sets of recent proposals from Europe’s banking regulator on market risk capital rules – designed to replace a series of patches following the financial crisis a decade ago – this week drew consternation and frustration from banks.

Both relate to implementation of standards from the Fundamental Review of the Trading Book that decide the capital banks need to hold against risk-taking positions in portfolios.

Following several...

CCPs’ end-of-waterfall rules allow for limited refinancing. Clearing members wishing to exit will still have to pay. Creditors’ remedies (bankruptcy) are unlikely to be available. Official policy expects CCPs to revive, but CCP rules may not enable that.

“We’ve just opened a new desk; it’s going to be very profitable,” the regional head of an international bank enthused. Nothing too unusual in that, except this was happening right after the financial crisis, and I was his UK regulator.

“Talk me through the risk profile,” I said.

“Sure. Let me get the desk head,” he replied.

“How about you explain it to me?” I responded.

It turned out he couldn’t – so I suggested he suspend trading, until such time as he could.

Business leaders can’t help

Bankers always expected the new IFRS 9 accounting standard to hurl loan-loss provisions higher, in something like a scattered arc. But they’ve been taken aback by just how dispersed and uneven the arc has turned out to be.

“Because of the way internal models are developed, some variability is to be expected, but this is a much bigger variability than I would have anticipated,” says Rastislav Kovacik, head of risk reporting at the Erste Group in Vienna, echoing the sentiments of many.

The

A TTC PD is defined as a PD that contains no information on the economic state and can vary over time due to changes in idiosyncratic risk; Vasicek correlation and subsequently PITness are derived from a regression between differenced time series of a common factor and ODF and Hybrid PD respectively; Heuristic segmentation framework splits obligors in homogeneous pools with respect to its dependency towards a shared common factor and PITness behaviour.  

Over four months this year, China’s government swooped in to shore up three rural banks.

In May, it seized the Baoshang Bank outright, something it had not done in nearly 20 years. Next, in July, one of the ‘Big Four’ state-owned banks suddenly became the largest stakeholder in the troubled Bank of Jinzhou. Then in August, the HengFeng Bank – about twice the size of the other two banks – was infused with cash by China’s sovereign wealth fund.

The inadequacies at the three banks varied, but all

Approach combines macroeconomic and style factors to guide the duration debate. Following the factor signals helps avoid drawdowns and improves the Sharpe ratio. Factor-based strategies historically performed well under rising interest rate regimes. The online appendix shows robustness across various countries and regions.

Since the UK’s Senior Managers and Certification Regime (SMCR) was implemented in 2016, there has been much carping about its failure to lead to a rise in high-profile scalps of individuals found guilty of significant wrongdoing in the financial industry. But the Financial Conduct Authority has plenty of live investigations pending into senior individuals suspected of “serious misconduct”, according to a senior regulator.

David Blunt, head of conduct specialists at the watchdog – in charge of

Machine learning is at the root of many recent advances in credit risk management. Techniques capable of making lending decisions far more rapidly, accurately (and cheaply) than a human are common at most large banks and credit card issuers. Self-learning algorithms are also at the front line of the battle against customer fraud. But what if those algos were just as fallible and flawed as the human loan managers who went before them?

As well as growing issues over the lack of ready