Hi David,
This question is on methodology of quantification of business risk VaR; what I could gather from various sources is as follows:
1.First the volatility of the time series data of actual and planned as a ratio should be found out both for the income as well as the cost. The income as well as the cost , both should be adjusted for market, credit and operational risk performance.
2. The data should further be adjusted from the holding period to planning period frequency.
3. The aggregated VaR should be found out based on correlation of two time series data and their respective volatility
4. The aggregated VaR should further be adjusted on the basis of sustainability factor. The sustainability factor is based on series of factors to describe the sustainability of earnings-at-risk hits. For example, if the factors are 1.0, 0.75, 0.5, and 0.25 respectively for year one, two, three, and four, this would imply that the full annual loss would be experienced in the first year, 75 % in the second year (due to first results in e.g. cost cutting ), 50 % in the third year and 25 % in the fourth year; at the end of year four it would be assumed that the cost structure would be fully adapted to the new income structure (following the earnings-at-risk hit). The sustainability factor for each year should be discounted by the target rate of equity return.
5. As it will be difficult for to determine /adjust income as well as the cost structure the VaR figure estimated will be within a confidence interval.
My query is in respect of the first step which states "The income as well as the cost , both should be adjusted for market, credit and operational risk performance."... can you please elaborate what is meant by this statement? Can you please refer to any material/ excel sheet to do the same? i.e adjusting the cost and income for market , credit and operational risk performance??
This question is on methodology of quantification of business risk VaR; what I could gather from various sources is as follows:
1.First the volatility of the time series data of actual and planned as a ratio should be found out both for the income as well as the cost. The income as well as the cost , both should be adjusted for market, credit and operational risk performance.
2. The data should further be adjusted from the holding period to planning period frequency.
3. The aggregated VaR should be found out based on correlation of two time series data and their respective volatility
4. The aggregated VaR should further be adjusted on the basis of sustainability factor. The sustainability factor is based on series of factors to describe the sustainability of earnings-at-risk hits. For example, if the factors are 1.0, 0.75, 0.5, and 0.25 respectively for year one, two, three, and four, this would imply that the full annual loss would be experienced in the first year, 75 % in the second year (due to first results in e.g. cost cutting ), 50 % in the third year and 25 % in the fourth year; at the end of year four it would be assumed that the cost structure would be fully adapted to the new income structure (following the earnings-at-risk hit). The sustainability factor for each year should be discounted by the target rate of equity return.
5. As it will be difficult for to determine /adjust income as well as the cost structure the VaR figure estimated will be within a confidence interval.
My query is in respect of the first step which states "The income as well as the cost , both should be adjusted for market, credit and operational risk performance."... can you please elaborate what is meant by this statement? Can you please refer to any material/ excel sheet to do the same? i.e adjusting the cost and income for market , credit and operational risk performance??
