Blog Week in Risk (ending Oct 9th)

[David Harper CFA FRM]

Forum discussions (selected only)

• ISDA OTC Derivatives Compliance Calendar updated by @seidu https://forum.bionicturtle.com/threads/isda-otc-derivatives-compliance-calendar-updated.9895/
• Can you elaborate on ARAROC? https://forum.bionicturtle.com/threads/p2-t7-300-economic-capital-topic-review.6830/#post-45348 adjusted RAROC is essentially an economic value added (EVA) concept because it wants the project to cover its (risk-adjusted) cost of capital; RAROC is partially risk-adjusted by not fully risk-adjusted
• VaR backtest discussion https://forum.bionicturtle.com/thre...sk-var-backtest-significance.3604/#post-45341 Thank you @arkabose for teasing out a helpful exploration of nuanced differences between the VaR confidence level and the desired confidence of the significant test
• Classic forward rate question (all FRM candidates should be able to at least follow the derivation in Question 202.3) https://forum.bionicturtle.com/threads/p1-t3-202-hulls-interest-rates-i-topic-review.5999/

Deutsche Bank

• There’s a Little Bit of Deutsche in Every Bank (But if banks are so much better capitalized than before the financial crisis, why do their shares suggest they are riskier?) http://www.wsj.com/articles/theres-a-little-bit-of-deutsche-in-every-bank-1475519830 “There are elements of truth in all three explanations [ie, speculative manipulation, markets are correctly pricing risk, or bank business models are permanently injured]. Investors clearly were complacent during the boom. Regulatory capital measures are far too complex to be reassuring. Bank business models are horrible, and the cost of fixing them will be high.”
• Deutsche Bank: A Greek Tragedy at a German Institution? by Aswath Damodaran http://aswathdamodaran.blogspot.com/2016/10/deutsche-bank-greek-tragedy-at-german.html
• Crisis of Globalization Lies Behind Deutsche Bank’s Troubles (Investors doubt the bank can earn an economic return on its equity, particularly when the amount it’s required to hold is a moving target) http://www.wsj.com/articles/crisis-of-globalization-lies-behind-deutsche-banks-troubles-1475434057
• Understanding Deutsche Bank’s $47 Trillion Derivatives Book (Size of figure can be misleading, but some of those assets are hard to value, stoking concern among investors) http://www.wsj.com/articles/does-deutsche-bank-have-a-47-trillion-derivatives-problem-1475689629 “In its 2015 annual report, Deutsche Bank said its exposure to derivatives was €41.940 trillion ($46.994 trillion). As a comparison, Germany’s gross domestic product was €3.032 trillion in 2015. But that raw size can be misleading, since it covers the notional value of the derivatives. For instance, the notional value of an interest-rate swap—the amount from which the payments to each party are calculated—may be large but the actual derivative may cover only small interest payments for either party. That makes the risk to either side much smaller than the figures suggest.”
• Deutsche Bank offers a tough lesson in risk (The idea that shareholders control banks is a myth. It is management that is responsible) by Martin Wolf https://www.ft.com/content/56be629e-896e-11e6-8aa5-f79f5696c731 “A first lesson is that banks remain highly fragile businesses. By their nature, banks are highly leveraged entities with ultra-liquid liabilities and far more illiquid assets. The balance sheets of many banks are also huge. Customers view the liquid liabilities of banks as utterly reliable stores of value and means of payment. Banks are also highly interconnected, directly, via their transactions with one another and, indirectly, via euphoria and panic.”
• CDS Markets Add to Deutsche Bank Gloom (Insurance against the lender's default in one year's time is now more expensive than for five years into the future) http://blogs.wsj.com/moneybeat/2016/10/04/cds-markets-add-to-deutsche-bank-gloom/

Banks (Wells Fargo, European)

• Wells Fargo sham-accounts scandal lifts lid on ridiculous cross-selling (Many banks in the US will have to review sales practices if they want to avoid regulatory scrutiny) https://www.ft.com/content/32b989ac-870f-11e6-a75a-0c4dce033ade “Meantime, all banks will have to avoid the slightest appearance of coercion. Lenders will have to practise good hygiene if they are selling anything beyond a logical bundle such as a checking account, debit account and savings account, says Bob Hedges, global head of the financial services practice at AT Kearney, the consulting group.”
• Wells Fargo Managers Pushed Overdraft Services http://www.wsj.com/articles/wells-fargo-managers-accused-of-pressuring-bankers-1476125151 “Overdraft fees have been a concern of regulators for some time. This is because of costs and moves by some banks in recent years to reorder transactions, posting larger transactions against an account first to increase chances a customer will overdraw the account and be charged numerous fees.”
• Fear of $10 Billion http://libertystreeteconomics.newyorkfed.org/2016/10/fear-of-10-billion.html “Ten billion has become a big number in banking since the Dodd-Frank Act of 2010. When banks’ assets exceed that threshold, they face considerably heightened supervision and regulation, including exams by the Consumer Financial Protection Bureau, caps on interchange fees, and annual stress tests.”
• European banks: the big contrarian trade with few takers (Years of underperformance from bank shares are a deterrent, rather than an incentive, for investors) https://www.ft.com/content/e4700888-893f-11e6-8cb7-e7ada1d123b1 “The ailments afflicting the region’s banks are wearily familiar. Their return on equity (RoE) — a common measure of a lender’s performance — has been hit by regulators’ demands they hold more capital. Technology is loosening their grip on core activities such as payments, while banks blame the ECB’s adoption of negative interest rates for corroding profits. The Stoxx Banks index of 26 members has an average price to book of 0.55, a figure that illustrates the dim view investors take of the sector’s current asset quality.”
• The Reward for Lending Italy Money for 50 Years: 2.85% http://www.wsj.com/articles/italy-markets-debut-50-year-bond-1475578790 “There were over €18.5 billion of orders for the 2067 bonds that priced at a yield of 2.85%, according to people familiar with the deal. The strong demand allowed the Italian treasury to raise more than the roughly €3 billion to €4 billion in long-dated bonds that analysts had expected.”
• How risky are the big U.S. banks? http://ritholtz.com/2016/10/risky-big-u-s-banks/ “One would think that as capital rises, market measures of risk should decline. That is, we would expect that with larger buffers, equity price volatility, correlation with the equity market (beta), and the probability an equity price collapse (option delta) would all be lower. In addition, we would think that preferred stock prices should benefit from the drop in the risk-free interest rate between the two periods. Yet in some cases, what should have gone down, went up. The option delta, which indicates the probability of a 50% plunge of the stock price over the next year, rose on average for the Big 6 from 3.6% before the crisis to 4.6% in 2015. And, instead of rising, the average price of preferred stock fell.”
• Big Banks Tweak Business Plans [aka, Living Wills or Resolution Plan] to Avert New Regulator Costs (J.P. Morgan, Wells Fargo, Bank of America, Bank of New York Mellon and State Street update models) http://www.wsj.com/articles/revised-living-wills-released-for-five-big-u-s-banks-1475611282 “The living wills requirement was created by the 2010 Dodd-Frank financial overhaul law, enacted in the wake of the financial crisis to, among other things, prevent a recurrence of government bank bailouts. This is the third round for the major banks. In 2012, they submitted plans but didn’t get any individual feedback. In 2014, the Fed and FDIC rejected all the plans. This year, they kicked back five, seeking revisions, and cleared three—from Goldman Sachs Group. Inc., Morgan Stanley and Citigroup Inc. — though the regulators still said those plans had weaknesses and shortcomings. Those three firms submitted updated plans that were also made public Tuesday.”

Fintech

• A Great Cost Migration Is Upending the Financial Industry https://www.bloomberg.com/view/arti...-migration-is-upending-the-financial-industry “The first [powerful trend] is the wholesale shift by investors from active management of assets to passive investments. In the last 36 months alone, there has been a $1.5 trillion swing out of active and into passive … The second, related trend is that money is moving from high-cost investments to low-cost investments. This is actually the mother of all trends: It’s the dominant force behind many investment changes in the financial industry today, including Janus’s decision to tie up with fellow asset manager Henderson Group.”
• JP Morgan is Quietly Developing a Private Ethereum Blockchain http://www.coindesk.com/jpmorgan-ethereum-blockchain-quorum/
• Lemonade Launch Metrics Exposed! (Stats from the first 48 hours after launching in NY) https://medium.com/@shai_wininger/lemonade-launch-metrics-exposed-5e1a616b2cc7#.wf0wfc3hi “Lemonade was the first insurance company on the planet to launch on Product Hunt. The PH launch by itself was a message to our users and the industry: Lemonade is a tech company doing insurance, not an insurer doing an app”

Climate (Matthew)

• Once Again a Cat 4 Storm, Potentially Disastrous Matthew Rolls Toward Florida Coast http://trtl.bz/wunderblog-matthew-1006 “There are no ideal analogs for Matthew’s expected track and strength along the Florida coast. Only a handful of hurricanes have struck Florida with winds as strong as Matthew’s current 140 mph, and the only hurricanes known to have been “coast scrapers” along the central and northern Florida coast were considerably weaker than Matthew. For most residents along the north half of Florida’s Atlantic coast, and perhaps the Georgia coast as well, Matthew will be the strongest hurricane in living memory.”
• Matthew Flings All-Time Surge and Rainfall Records Across Southeast https://www.wunderground.com/blog/J...e-surge-and-rainfall-records-across-southeast “It will be some time before we have a more complete sense of Matthew’s toll, but we already know that it is the deadliest hurricane in the Western Hemisphere since 2005.”
• Hurricane Matthew has potential to trigger cat bonds & ILS: RMS http://www.artemis.bm/blog/2016/10/06/hurricane-matthew-has-potential-to-trigger-cat-bonds-ils-rms/ “But whatever happens the ILS and catastrophe bond market needs to remain alert to the fact that there is a good chance it will be called on to pay some claims, due to collateralised reinsurance layers being triggered, and that if the more severe scenarios play out then everything could be in play, including exposed catastrophe bonds. With a significant proportion of the outstanding catastrophe bond market exposed to Florida hurricanes, perhaps as much as 60% or more of risk capital outstanding, we are likely to see increasing interest in buying and selling cat bonds at more distressed pricing levels as Matthew nears.”
• Hurricane Matthew Could Impact Renewals, Reinsurers http://www.riskmanagementmonitor.com/hurricane-matthew-could-impact-renewals-reinsurers/
• Updates from RMS on Major Hurricane Matthew http://www.rms.com/blog/2016/10/07/...-matthew-from-the-rms-hurricane-and-ils-team/ “So now we have initiated the next phase of RMS Event Response operations, with our attention shifting from the regular, reactive stochastic event selections to a comprehensive interrogation of all causes of loss – both modeled and unmodeled. It is this work that will form the basis of the RMS official industry loss estimate.”
• What Made Hurricane Matthew so Memorable Meteorologically? http://www.air-worldwide.com/Blog/What-Made-Hurricane-Matthew-so-Memorable-Meteorologically-/
• Hurricane categories explained (What's the difference between a category 1 and a category 5)? http://www.propertycasualty360.com/...ries-explained?slreturn=1475882216&page_all=1
• A Milestone for Carbon Dioxide in the Atmosphere http://www.nytimes.com/2016/10/04/science/atmospheric-carbon-dioxide-400-ppm.html
• Bonds and Climate Change 2016: Canada Edition https://www.climatebonds.net/bonds-and-climate-change-2016-canada-edition

GARP and Basel (BIS)

• Tools and Standards for Basel’s FRTB (Technology solutions, along with a standardization initiative by ISDA, seek to help firms deal with, if not clear away, the market risk rule’s remaining ambiguities) http://www.garp.org/#!/risk-intelligence/detail/a1Z40000003LKwTEAW/tools-standards-basel-frtb Reminder that the most recent, relevant document on the Fundamental Review of the Trading Book (FRTB) is http://www.bis.org/bcbs/publ/d352.htm
• Bank capital: a revised Basel framework (Remarks by William Coen, Secretary General of the Basel Committee) https://www.bis.org/speeches/sp161007.htm “First, our goal is to finish by the end of the year. The Committee's post-crisis reforms have been comprehensive and wide-ranging. I am pleased to say that we are close to finalising these reforms, which will provide clarity and certainty to supervisors and market participants. Second, the bulk of the outstanding reforms relate to reducing excessive variability in risk-weighted assets. A high degree of variability in capital ratios has been demonstrated across a number of empirical studies by the Committee, academics and analysts. The Committee's objective is to restore the credibility of the risk-based capital framework, which is an integral element of the Committee's post-crisis reforms. This is not an exercise in increasing regulatory capital requirements, although I do not rule this out as a possible outcome for outlier banks.”
• Basel III – Capital Adequacy – US implementation https://financetrainingcourse.com/education/2016/10/basel-iii-capital-adequacy-us-implementation/
• Comprehensive Capital Analysis and Review (CCAR) & Basel III – Overview https://financetrainingcourse.com/e...-analysis-and-review-ccar-basel-iii-overview/

Low interest rates

• An Interest Rate Hike Would Be Ugly for Bonds http://financecontributors.tumblr.c...an-interest-rate-hike-would-be-ugly-for-bonds “Monday’s class was all about duration, which is a concept most of you are hopefully familiar with. I like to say that duration has two definitions: 1. The weighted average time to maturity of all coupon and principal payments; 2. The sensitivity of a bond’s price to changes in interest rates. (Some people refer to duration as a measure of bond price volatility. But volatility is something different. It’s the sensitivity to changes in interest rates. Small but important semantic difference.)”
• QE purchases near record even as doubts grow (Although doubts over central banks’ policies have risen, the pace of purchases is near an all-time high) https://www.ft.com/content/060c691c-8a0f-11e6-8aa5-f79f5696c731
• Low Interest Rates (Speech by Vice Chairman Stanley Fischer) http://www.federalreserve.gov/newsevents/speech/fischer20161005a.htm “The low interest rate environment presents us with four key questions: (1) Are ultralow interest rates part of the so-called new normal for the global economy, or are they mostly transitory? (2) How concerned should we be, if at all, about the current interest rate environment? (3) What determines the level of interest rates over the longer run? (4) What can policymakers do about chronically low interest rates?”

Cyber

• Crisis of the Week: Breach Puts Yahoo in Reputation Crosshairs http://blogs.wsj.com/riskandcomplia...k-breach-puts-yahoo-in-reputation-crosshairs/ “Data breaches have become the textbook crisis communications case studies of our era, and a clear playbook has been developed about how to handle a breach well. It seems Yahoo cut class that day.”
• 6 categories of questions you'll be asked when applying for cyber coverage http://www.propertycasualty360.com/2016/10/05/6-categories-of-questions-youll-be-asked-when-appl

International

• International Monetary Fund issued three reports: World Economic Outlook http://www.imf.org/external/pubs/ft/weo/2016/02/index.htm, Global Financial Stability Report (GFSR) http://www.imf.org/external/pubs/ft/gfsr/2016/02/index.htm, and Fiscal Monitor(FM) http://www.imf.org/external/pubs/ft/fm/2016/02/fmindex.htm “At 225 percent of world GDP, the global debt of the nonfinancial sector—comprising the general government, households, and non-financial firms—is currently at an all-time high. Two-thirds, amounting to about $100 trillion, consists of liabilities of the private sector which, as documented in an extensive literature, can carry great risks when they reach excessive levels.”
• Pound sinks to post-Brexit vote low as FTSE 100 eyes record https://www.ft.com/content/a97ac984-89fd-11e6-8cb7-e7ada1d123b1

Other

• Sortino Ratio - Excel http://www.analystforum.com/forums/cfa-forums/cfa-general-discussion/91354229 “For the downside deviation various articles are showing different formulas … Some articles show that N (total periods) should be all periods including 0, some suggest N should just be for the negative periods as that is what we are trying to work the volatility on.” Classic debate. Here is a good presentation by Red Rock Capital that somebody on the thread shared http://trtl.bz/red-rock-capital-sortino I agree with them on the treatment of zeros as reflected in our RAPM learning spreadsheet (I learned this in the CFA CIPM actually): returns above the minimum acceptable return (MAR) count as zeros and they are not excluded. Consequently, the Sortino ratio improves as more returns exceed the MAR, as you might expect. My only semantic quibble is that, if the MAR happens to be set equal to the mean return, then the denominator is called a “semi-deviation.” But the correct denominator of a Sortino is the “downside deviation” which allows for any MAR (aka, target return).
• Return of the Quants: Risk-based Investing (CFA Institute Conference Proceedings Quarterly http://trtl.bz/2dLz84q “Managed volatility and covered call writing are two of the few systematic investment strategies that have been shown to perform well across a variety of empirical studies and in practice. So far, they have been studied mostly as separate strategies. It turns out that when combined, these two strategies create a powerful toolset for portfolio enhancements.”
• Black Swans: 9 Recent Events That Changed Finance Forever http://www.visualcapitalist.com/black-swans-9-recent-events-that-changed-finance-forever/
• Currency Hedging: Aiming for Efficiency (PIMCO blog) http://blog.pimco.com/2016/10/03/currency-hedging-aiming-for-efficiency/ “In fact, our research found Australian and Japanese investors may be able to reduce tail risks, as measured by conditional value at risk (CVaR), in a standard 60/40 portfolio by up to 1.5 percentage points and 3.0 percentage points, respectively, without sacrificing returns, relative to having a uniform hedge ratio at the portfolio or asset level.”
• Inside Lloyd's: Demystifying the inner workings of the world's most famous insurance market http://www.propertycasualty360.com/...s-of-london-looks-like-on-the-insi?page_all=1
• Venture Capital: It is a pricing, not a value, game! http://aswathdamodaran.blogspot.com/2016/10/venture-capital-it-is-pricing-not-value.html “I have made the distinction between value and price so many times before that I sound like a broken record, but I will make it again. You can value an asset, based upon its fundamentals (cash flows, growth and risk) or price it, based upon what others are paying for similar assets, and the two can yield different numbers.”
• 3 Conclusions on TARP 8 Years Later https://www.treasury.gov/connect/blog/Pages/3-Conclusions-on-TARP-8-Years-Later.aspx “On this eighth anniversary, we are reminded that this program was not only central to avoiding a financial collapse and getting the economy growing again, but that it also returned more money to taxpayers than they invested. To date, a total of $433.7 billion has been disbursed under TARP. As of August 31, cumulative collections under TARP, together with Treasury’s additional proceeds from the sale of non-TARP shares of AIG, total $442.1 billion, exceeding disbursements by $8.4 billion. A program that some once feared would lose taxpayers hundreds of billions of dollars has generated a positive return.”

Books and Courses

• Credit Risk Analytics: Measurement Techniques, Applications, and Examples in SAS is here http://amzn.to/2e4OBLV I bought this, it looks good, authors already were responsive to my query about their dataset. Their site is here at http://www.creditriskanalytics.net/table-of-content.html
• Cathy O'Neil on Weapons of Math Destruction (EconTalk Episode) http://www.econtalk.org/archives/2016/10/cathy_oneil_on_1.html Book is here http://amzn.to/2el8QrN
• A Dozen Things You can Learn by Reading “The Success Equation” by Michael Mauboussin https://25iq.com/2016/10/01/a-dozen...g-the-success-equation-by-michael-mauboussin/
• Trading and Electronic Markets: What Investment Professionals Need to Know https://blogs.cfainstitute.org/investor/2016/10/06/book-review-trading-and-electronic-markets/ “Harris’s concise writing style and numerous examples make the most difficult concepts approachable. The book is valuable not only for prospective traders but also for portfolio managers, who depend on traders to implement their strategies.” Here is the (free) book http://trtl.bz/cfa-harris-trading-electronic
• Excel 2013: Financial Functions in Depth by lynda.com (Skill Level Intermediate, 2h 38m) Durationhttps://www.lynda.com/Excel-tutorials/Excel-2013-Financial-Functions-Depth/504660-2.html “Topics include: Analyzing loans, payments, and interest; Calculating depreciation; Determining values and rates of return; Calculating bond coupon dates and security durations; Calculating security prices and yields; Calculating prices and yields of securities with odd periods; Analyzing simulation results”