The Standardized Approach (SA) is here to stay. All banks subject to the Fundamental Review of Trading Book (FRTB) will now be required to use the Standardized Approach in some capacity, even if their trading desks utilize an Internal Model Approach (IMA). Desks using an IMA will still need to calculate the SA and compare the two—with the SA possibly providing a floor to the capital requirements in many cases. As such, the Sensitivity Based Approach (SBA) will be a critical component of FRTB reporting, and while many financial institutions are already prepared to conduct SBA calculations—many are not.

What does the SBA entail when it comes down to underlying methodology and risk sensitivity calculations for Delta, Curvature and Vega charges and what does its implementation mean from a business impact perspective?

Highlights of the paper include:

  1. Breakdown of Recent Key Enhancements to FRTB and the Sensitivity Based Approach
  2. SBA Methodology, Structure and Procedure to Calculate Delta Risk Charge, including:
  • Examination of a case in which Delta approximation is not enough to cover all of the loss implied by a sample swaption PV when rates move up by 2.4%—and why an additional risk charge is needed on top of the Delta Risk Charge.
  1. SBA Methodology, Structure and Procedure to Calculate Curvature Risk Charge, including:
  • Examination of a case in which there is a short-position on a sample swaption, and why there is Curvature coming in. Conversely, why when long-dated on this same swaption, there is no Curvature.
  • Why the Curvature Capital Charge is now considered essential by regulators to reduce portfolio losses during financial stress periods
  1. SBA Methodology, Structure and Procedure to Calculate Vega Risk Charge, including:
  • Examination of why Vega capital charge is also now considered essential by regulators to reduce portfolio losses during financial stress.
  • A sample of GIRR Vega Intra-Bucket Correlation matrix—why and how it works.
  • Demonstration of Two-Step Aggregation (aka. Cascading Approach to Variance Calculation) and why Basel Committee recommends this approach.
  •  Exploration of how to avoid Vega and Delta charges adding up when no correlation exists

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Author BiographIES

Paolo TarpanelliPaolo Tarpanelli, PhD, Senior Financial Engineer, Numerix
Paolo Tarpanelli works as a Senior Financial Engineer in Numerix’s Milan office, helping European clients price and manage the risk of their multi-asset class derivative portfolios. Prior to Numerix, Dr. Tarpanelli worked as Quantitative Pre-Sales Analyst at Thomson Reuters where he implemented pricing models for structured products and developed new tools for portfolio optimization techniques and high frequency trading. Before Thomson Reuters, he worked as a Quantitative Analyst in the Department of International Structured Products at Merrill Lynch. Dr. Tarpanelli holds an Economics degree in Quantitative Methods from the Universita degli Studi of Perugia, where he also received his PhD which focused on Risk Management in Commodity Markets.
 

Juan VargasJuan Vargas, Senior Financial Engineer, Numerix
Mr. Vargas joined Numerix in August 2014, where he is currently working as Senior Financial Engineer. He is focused on developing solutions for clients to price vanilla and exotic products as well as market risk and valuation adjustment measures using Numerix analytics. Before joining Numerix, Mr. Vargas worked as Quantitative Analyst in the valuation services team at Pricing Partners (now part of Thomson Reuters). Mr. Vargas holds a Master’s degree in Financial Engineering from Universite Paris Dauphine.

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