Value at Risk
|There are a number of challenges when it comes to communicating, enforcing and setting limits in a trade, treasury, portfolio and risk function.|
One big factor is the language of limits. When it comes to building consensus across Traders, Risk and Credit, it is like a tower of Babel. Traders speak and understand Stop loss, risk managers work and vouch for value at risk, credit officers track and live for PSR (Pre-Settlement). How do we link the three?
Our short "Setting Limits" video course picks up and builds up on the core concepts covered in two of our earlier courses, The Quant Crash Course and Calculating Value at Risk and introduces the linkage between Stop loss and Value at Risk by defining the median trading loss.
The median trading loss is the likely trading loss we expect to see every 2nd or 3rd trading day. We then link the median trading loss to a VaR confidence level that can be used for communicating results and suggesting limits to Board Risk Committees. To build the intuition for that conversation we introduce the concept of odds and highlight the interpretation problem Board members face when seeing extreme probabilities (the problem first highlighted and suggested by Nicholas Nassim Taleb).
In the final part of our course we switch our focus to PSR (Pre Settlement Risk) limits calculations. PSR limits are counterparty limits that calculate the worst case likely loss on account of default on settlement date by a given counterparty. Once again a VaR measure subject to changing volatilities, our approach highlights the usage of maximum, minimum and median volatilities and suggests that the underlying VaR estimates need to be reviewed more frequently than the once in 2 or 3 year practice we have observed in the region.
Comfort with basic mathematics and EXCEL and an understanding of the risk management environment together with a familiarity of financial markets, banking industry, economic capital, portfolio management concepts and the Basel II framework.
This course is targeted at intermediate and advanced users and individuals responsible for capital allocations, limit setting and risk management with the treasury functions of banks and other financial institutions as well as finance departments of non-financial organizations.
Here is the structure of the course.
|Session 1 – Setting Limits||33:47 mins|
Session One – Setting Limits
|We consider how VAR is used in allocating, calculating and defining optimal levels for limits: Stop Loss Limits, Pre-Settlement Risk (PSR) Limits and Margin haircuts for bonds. We discuss how to set up stop loss thresholds without hindering trading while taking into account market volatility, i.e. median likelihood trading loss threshold. We consider how a financial institution’s board of directors interprets and assesses the credibility of VAR results. We show how Stop Loss may be calibrated to the VaR threshold. For PSR limits we review the market practice of using average volatility in the calculation of counterparty limits and we highlight the value of using a measure based on the maximum trailing volatility as well as the importance of carrying out a frequent, dynamic review of the limits management system in light of a changing market environment|
View a sample of session one
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