Case Study: Regulation – Quantitative Development – Market Risk – FRTB (PLA)

ABOUT

Our Client, a Global Investment Bank, as part of an FRTB driven internal model review of the FO pricing and risk models used to generate Risk Based PnL – identified a number of breaks that were impacting their Exotic and Flow Rates products. Consequently, the business engaged us to conduct an impact assessment of the identified breaks, and where possible to develop prototypes and implement solutions to resolve the underlying issues causing the breaks to ensure the business could meet the FRTB mandated PnL Attribution tests.

 

OUR CLIENT CONTEXT

We undertook a comprehensive reconciliation of the breaks identified in the FO models, documenting how they were impacting the generation of key metrics such as spread risk (forward spreads at front end of curve), basis risk (long end of the curve) and sensitivities used by the Traders. This process entailed a model risk assessment where our consultants would assess the appropriateness of the model selection, then test the model assumptions, and come up with alternate prototypes before testing and implementing them into production.

 

OUR APPROACH

As an ongoing project, the majority of the challenges we have faced so far have been calibration issues. For example – when looking at the use of SABR models for pricing swaptions, when term structure shocks where applied in low interest rate environments there was a tendency to produce negative variance at certain illiquid tenors at the long end of the curve which meant the PnL strips couldn’t be generated.

 

CAPABILTITIES WE DELIVERED

  • The solution we have been developing includes building a reduction matrix for producing relative shocks. For example when IMA defined shocks were too big (50bp over 100yrs, we implemented a MC-Sim to reduce it to a relative shock of 20bp over 10yrs).
  • Other examples include the use of Taylor-approximations to fill data gaps when calibrations failed on day 7 of a 10day PnL strip.

 

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