This request requires extensive risk management knowledge especially in relation to the fundamental review of the trading book. The work consists of analyzing an excel file and calculating various elements as indicated. Please accept this request only if you are familiar with these concepts, as you won’t find the answers online and you have to conduct the calculus yourself (you need to present how you reached the final answers).
Request: You are a risk manager in very simple bank. All you trade is SPX index positions and WTI. You are tasked with assessing the impact of the new FRTB capital rules on your trading book. We have provided historical data on these assets. Your job is to compute the impact of the change in risk model and to explain these to your managers.
|1)Study the 3 attachments as well as Hull Chapter 18. Note that equation 18.1 is missing a square root on the output of the formula.
2)Briefly summarize the main changes, at a high level, between Basel 2.5 and FRTB. What do you think are the regulators’ motivation for the changes?
3)Use the attached spreadsheet: FRTB Data, to perform the Following Calculations
-Assume $1mm of SPX and $2mm of WTI as your position
-Note that SPX is a 10 day liquidity asset and WTI is a 20 day asset for the internal model
-Equity risk weight for standard model is 55% (for SPX), commodity risk weight is 35% (for this commodity)
O old VaR
O old stressed VaR
O old capital charge (Basel 2.5)
O stressed ES of both assets combined
O stressed ES WTI
O liquidity adjusted ES (new capital charge)
O standardized equity risk charge
O standardized commodity risk charge
O standardized risk charge for portfolio
O floor of standard charge to be compared to internal model (72.5% long term)
4)Answer the questions below. Please note that in this study we are not considering charges for default. I.e. we are not looking at the replacements for specific risk and IRC charges.
Questions to Answer:
1. The FRTB standard model looks a lot like a VaR model but with 3 sets of fixed correlations within risk classes to obtain the risk charge for each risk class. The total (delta) risk charge for all risk classes is the sum of the risk charges for each risk class. Why do you think the regulators decided to add risk charges across risk classes assuming 100% correlation?
2. The floor for the standard model is going to be 72.5%. that means that using an internal model can’t save more than 27.5% capital. What implication do you think this has for adoption of the internal models? Note that in our example we only used 10 and 20 day liquidity assets. The assets with longer liquidity periods get much higher charges.
3. Does the complexity of the model and the arbitrary set of risk factors make it difficult or easy to manage a business using these capital models to measure risk. Why?
4. From a risk management perspective, briefly discuss the merits of using ES instead of VaR.
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