Blog Week in Risk (ending Oct 2nd)

David Harper CFA FRM

David Harper CFA FRM

David Harper CFA FRM
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Selected Questions and Answers (Q&A) in the forum
Practice questions submitted (external source) in the forum
My favorites external articles this week
GARP, Risk Managers and John Hull
Fed, BIS and FRTB
  • The Federal Reserve Board on Monday invited public comment on a proposed rule to modify its capital plan and stress testing rules for the 2017 cycle http://www.federalreserve.gov/newsevents/press/bcreg/20160926a.htm
  • BIS: Challenges of low commodity prices for Africa http://www.bis.org/publ/bppdf/bispap87.htm
  • BIS: Guidance on the application of the Core Principles for Effective Banking Supervision to the regulation and supervision of institutions relevant to financial inclusion http://www.bis.org/bcbs/publ/d383.htm
  • BIS: Frequently asked questions on the supervisory framework for measuring and controlling large exposures http://www.bis.org/bcbs/publ/d384.htm
  • BIS Working paper, Leverage and risk weighted capital requirements http://www.bis.org/publ/work586.htm “we seek to answer three questions: 1) How does the leverage ratio behave over the cycle compared with the risk-weighted asset ratio? 2) What are the costs and the benefits of introducing a leverage ratio, in terms of the levels and volatilities of some key macro variables of interest? 3) What can we learn about the interaction of the two regulatory ratios in the long run? The main answers are the following: 1) The leverage ratio acts as a backstop to the risk-sensitive capital requirement: it is a tight constraint during a boom and a soft constraint in a bust; 2) the net benefits of introducing the leverage ratio could be substantial; 3) the steady state value of the regulatory minima for the two ratios strongly depends on the riskiness and the composition of bank lending portfolios.”
  • FRTB: A work in progress (Banks cannot wait for clarification but must forge ahead) http://www.risk.net/risk-magazine/opinion/2471814/frtb-a-work-in-progress
  • FRTB: Lining up the fundamentals (Sponsored Q&A: Asset Control, Murex, Vector Risk, CompatibL and Parker Fitzgerald) http://www.risk.net/risk-magazine/advertisement/2471698/lining-up-the-fundamentals
Cyber
  • Internet Organised Crime Threat Assessment (IOCTA) 2016 Report is here http://trtl.bz/iocta-cyber-2016 The eight cybercrime trends from the 2016 IOCTA are crime-as-a-service, ransomware, criminal use of data, payment fraud, online child sexual abuse, abuse of the darknet, social engineering, and virtual currencies
Low interest rates
  • How Interest Rates Affect Stock Market Returns http://awealthofcommonsense.com/2016/09/how-interest-rates-affect-stock-market-returns/ “The risk free rate to be used is up for debate, but using the 10 year treasury bond as a proxy gives us a historical equity risk premium of about 4.5% per year since the late-1920s. This means that the S&P 500 has outperformed government bonds by that amount, on average, in that time … Of course, we’re really in uncharted territory at today’s interest rate levels. The 10 year yield currently stands at 1.5% or so. In the historical numbers I looked at the 10 year was just barely below 2% for a couple months but has never really spent much time below that level until recent years. No one really knows what will happen with rates this low for this long. It’s never really happened before.”
  • Negative interest rate policies: Channels and consequences http://voxeu.org/article/negative-interest-rate-policies-channels-and-consequences “Transmission channels of monetary policy under NIRP are conceptually analogous to those under conventional monetary policy. Specifically, NIRP are expected to be transmitted mainly through the interest rate, credit, portfolio, and exchange rate channels. However, complications associated with these channels under NIRP could limit policy effectiveness, particularly if they have adverse effects on the financial sector. For example, in the case of the interest rate channel, commercial banks may hesitate to impose negative rates on depositors in order to prevent a loss of their deposit base.”
Deutsche Bank
Banks and Peak Finance
  • Traditional banking is on borrowed time — so why invest? (Competition, loss of trust and low interest rates have eroded the business model) https://www.ft.com/content/68dd6baa-865d-11e6-a29c-6e7d9515ad15
  • Brussels ready to push back on bank capital rules (EU finance chief rejects international plans backed by US to improve bank safety) https://www.ft.com/content/63c1726a-861c-11e6-8897-2359a58ac7a5 “Basel revisions should recognise that in a number of areas, markets in Europe face different challenges than elsewhere,” Mr Dombrovskis said. “Equalising average risk weights across the world cannot be the answer. We want a solution that works for Europe and does not put our banks at a disadvantage compared to our global competitors,” he said.
  • Peak Finance Looks Like It's Over https://www.bloomberg.com/view/articles/2016-09-27/peak-finance-looks-like-it-s-over “Trading and asset management are not the only areas of finance -- real estate and insurance are also huge, and retail banking, private equity, traditional investment banking and hedge funds are all substantial. But each is under attack, mainly from disruptive technologies, and to a lesser extent, regulatory changes.”
Governance
Risk surveys
  • Society of Actuaries’ Ninth Annual Survey of Emerging Risks: Summary of Findings https://www.soa.org/Research/Research-Projects/Risk-Management/emerging-risks-findings.aspx “Risk managers perceive cyber security, financial volatility and terrorism to be the most impactful current and emerging risk categories for the second year in a row … When asked to choose up to five emerging risks, cyber security emerges as the clear winner with 65 percent of respondents, followed by financial volatility (45 percent), terrorism (37 percent), asset price collapse (31 percent) and regional instability (26 percent).”
  • Clements Worldwide Risk Index (Summer/Fall 2016) http://trtl.bz/clements-global-risk-index-fall-2016 “Business interruption is the greatest source of losses in every region of the world, except Africa. Property damage ranks second for respondent organizations in terms of losses. [General liability ranks third:] Organizations operating outside the U.S. are experiencing unprecedented growth in third party lawsuits from staff, customers and others.”
  • 2016 Wall Street Reputation Survey by Makovsky http://trtl.bz/2dCkaR5 “86% of executives [at financial services institutions] said the 2008 financial crisis still has a major effect on perception of their companies.”
Quantitative
  • The Sharpe Ratio As An Efficiency Metric https://thepfengineer.com/2016/09/24/the-sharpe-ratio-as-an-efficiency-metric/ “If one were to use the Sharpe Ratio as the sole criteria for making investment decisions then Treasury Notes have clearly been superior to US stocks. The comparison here isn’t all that different from the Prius and the drag racer I mentioned previously. Efficiency and absolute performance are very different things. One option may be more efficient, but is it really sufficient to accomplish the task at hand? It probably depends on what the objective is in the first place. Sharpe himself recognized that using only mean return and variance (or standard deviation) was too simple to fully capture the needs of every investment decision.”
  • Forecasting volatility http://financecontributors.tumblr.com/post/151115608836/forecasting-volatility “When people talk about volatility, one of the generalizations they make is that, volatility is trending in the short-term and mean-reverting in the long-term. Let’s refine this a bit, and consider a few observations about volatility … The volatility of volatility itself is positively correlated with the level of volatility. In other words, when volatility is already high, it is more likely to change a lot. When it’s low, it’s more likely to not change.”
  • Quants Do the Math on a New Target: Insurance http://www.wsj.com/articles/quants-do-the-math-on-a-new-target-insurance-1475006920
International
  • Bye-bye covered interest parity http://voxeu.org/article/bye-bye-covered-interest-parity “Covered interest parity (CIP) states that the interest rate differential between any two currencies in the money markets should equal the differential between the forward and spot exchange rates. Otherwise, arbitrageurs could make a seemingly riskless profit. For example, anyone able to borrow dollars cheaply in the cash market could profit by lending them via the FX market for yen through a swap – effectively selling dollars for yen today and repurchasing them at the forward rate. The intuition is that both cash and swap transactions amount to borrowing dollars for a given period, so that their cost should be the same.”
  • In Japan, my kingdom for a dollar hedge http://ftalphaville.ft.com/2016/09/29/2176279/in-japan-my-kingdom-for-a-dollar-hedge/
  • China’s Ambitious Plan to Make the Yuan the World’s Go-To Currency http://www.bloomberg.com/graphics/2016-chinese-yuan/ “One of the basic definitions of a reserve currency is that it must be freely traded. And the yuan is not quite there yet. The People’s Bank of China is often suspected of intervening in the market to nudge its exchange rate one way or the other. The central bank also limits onshore daily moves to 2 percent on either side of a fixing that it sets. Then there are capital controls, which restrict the ability to move money out of the country.”
  • Interconnectedness in the Global Financial Market https://financialresearch.gov/worki...connectedness-in-the-global-financial-market/
Climate
Other
 
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