A two-day course on methods and changing regulatory requirements for measuring and managing market and spread risks in the trading book
The purpose of this seminar is to give you an overview and a good understanding of the new measures that were introduced with "Basel 2.5" and of the measures which are expected to be introduced as a part of Basel III and those that are expected to follow in the coming years from the recommendations in the Basel Committees "Trading Book Review".
We start with an overview of regulatory developments since 1995. We explain the measure of Value-a-Risk and we discuss its advantages and shortcomings, including the problems with illiquidity and lack of coherence. We then thoroughly explain the measures introduced in the so-called "Basel 2.5" framework to address these weaknesses: Stressed VaR, Incremental Risk Charge and the Comprehensive Risk Measure for securitization transactions. We explain the concept of "liquidity horizons" and we demonstrate how the calculations are performed translated into capital charges. Further, we discuss the proposed treatment of hedging and diversification in the trading book and of the revised internal risk models based approach and the revised standardized (partial risk factor) approach.
We then look at the changes suggested in the updated "Fundamental Trading Book Review", in particular the proposed switch from VaR to "Expected Shortfall" (ES). We explain why ES is, in theory, a better (more coherent) risk measure than VaR. We show how ES is calculated, how ES expectedly will translate into capital charges, and how ES and other risk measures are used in practical trading book risk management. We also discuss the practical difficulties in back testing ES model and suggest possible solutions to these problems.
Further, we look into the new CVA risk capital charge, which came into effect in January, 2013. We explain how the CVA risk capital charge is calculated according to standardized and advanced methods under the Basel III rules. We also explain the similarities and differences between the related concepts CVA, DVA and FVA and demonstrate how they are using in pricing of derivatives.
Finally, we discuss the possible consequences of these changes in the regulatory treatment of the trading book for banks' business models, costs structure and profitability.