Setting Market Risk Limits – Learning Roadmap
Risk models only have value if they are used effectively in combination with limit management and control process. While a conventional view of the control function is that it requires and relies on reports, the key is not generation of quantitative numbers, formatted in ten different variation and cuts; it is the interpretation and application of the analysis behind that reports that matters.
The objective of a risk function is to not just gather data, run reports, submit and analyze them, it is to ensure that unpleasant surprises and their impact is limited. While you can’t control the timing and magnitude of such surprises, a well managed and well run risk function can help manage expectations as well as plan ahead for unexpected shocks. Limits play a major role in achieving that objective.
What are the prerequisites?
The choice of the market risk measure that will be monitored and against which limits will be set is a very important element in determining market risk limits. Will we be monitoring the volatility, daily VaR, correlations, betas, duration of the security? Will we be looking at the overall impact on shareholder value or net trading and interest income?
The first step therefore in setting market risk limits is to know what the underlying metric is and how it is determined. The following courses provided detailed procedures for calculating these measures:
- Duration & Convexity Calculation Example – Relevant for Fixed Income and Interest Sensitive portfolios
- Market Risk Metrics – Relevant for all product and desks that rely on trading securities exposed to price risk
- Correlation – For a better understanding of the measure behind risk, reward and relationships across asset classes and securities
- Calculating Value at Risk (VaR) – A review of the VAR measure
- The ALM Crash course and survival guide – Required reading for setting ALM and Interest Rate mismatch limits.
What topics are covered?
We will first review the core principles for setting effective limits and then present and overview of the different limits that may be defined:
Next we walk through detailed methodologies and related examples for defining Capital Loss and Stop loss limits; Value-at-Risk (VaR) and Regulatory Approach limits from a Basel II IMA perspective; Duration, Convexity and Present Value of Basis Point (PVBP) limits;
- Capital Loss and Stop Loss – Defining risk appetite?
- Setting Limits: Value at Risk and Regulatory Approach Limits
- Limits: Trading Limits – Duration, Convexity and PVBP Limits
- Setting Risk Limits: Worst Case Loss versus most likely loss
What are the additional topics I can read up on?
- Liquidity Management – Setting limits for liquidity risk
- Setting Limits: Interest Rate Risk Management
Stress testing market risk measures to see their sensitivity to other risk factors/economic environments:
Related Online Courses
Related PDF Files
- Setting Counterparty Limits – Package
- Calculating VaR – Includes case study
- Asset Liability Management (ALM) Crash Course – Package
Related EXCEL Files
- Duration Convexity Example
- Calculating VaR –EXCEL Example
- ALM Crash Course – EXCEL Example (Examples include: Cost to close liquidity gaps, Cost to close interest rate risk, Earnings at risk, Market value of equity)