Numerix Blog

Food for Thought: Innovative Model Risk Management Theories to Consider in the New Year

We recently looked at several key areas of focus when it comes to effective model risk management in 2012.  In Massimo Morini’s recent book, “Understanding and Managing Model Risk: A Practical Guide for Quants, Traders and Validators” (The Wiley Finance Series), he focuses on model risk and validation from a more theoretical approach.

He explores the two different approaches to model validation set forth by the ‘Fathers of Quantitative Risk Management’-- Emanuel Derman, Professor at Columbia University, former Head of Quantitative Risk Management at Goldman Sachs, and author of “Models.Behaving.Badly” and Riccardo Rebonato, Head of Front Office Risk Management and Quantitative Analytics, RBS Global Banking & Markets, Visiting Lecturer, Mathematical Finance, Oxford University, and member of the Board of Directors of ISDA and GARP.

According to Emanuel Derman’s value approach, a model risk manager should consider the following questions:

1. Is the payoff accurately described?
2. Is the software reliable?
3. Has the model been appropriately calibrated to the prices of simpler, liquid constituents that compromise the derivative?
4. Does the model provide a realistic (or least plausible) description of the factors that affect the derivative’s value?

Mr. Derman’s value approach can be summarized by the following concept: “Model risk is the risk that the model is not a realistic (or at least plausible) description of the factors that affect the derivative’s value.”

Rebonato’s price approach, on the other hand, can be summarized by the following concept: “Model risk is the risk of a significant difference between the mark-to-model value of an instrument, and the price at which the same instrument is revealed to have traded in the market.”

The contribution Morini makes to the above theories is that he argues that the two approaches are actually the same – or at least have the same practical consequences to practitioners. Certainly, all of these concepts, along with Morini’s new book, provide food for thought when it comes to managing your model risk in 2012. If you have further questions, or would like more information about model risk management solutions, please contact sales@numerix.com.

Improving Transparency in the US Retail Structured Products Market

Despite certain challenges and changing client expectations, the US retail structured products market is a growing industry, with USD 20 Billion of issuance in the last 12 months and approximately 4,000 new products issued annually since 2008. Clearly a less mature market than the well-established structured products market in EMEA, the popularity of structured products in terms of investment, growth and popularity has not accelerated to the level of other investment types, such as mutual funds, ETFs and ETNs in the US market.

Indeed, there is a need for increased education and transparency in the US retail structured products market. For some US investors, “structured is still a bad name with significant headline risk in the marketplace,” explained Jim Jockle, SVP at Numerix, during the webinar discussion. “A direct result of the recent crisis is that investors today approach any investment opportunity with a healthy skepticism to be better informed when making an investment decision,” he added. “Given the lack of maturity of the US structured products market, investors do not have access to the independent tools needed to evaluate structured products or compare them to other products prior to the investment; and, valuation and past performance measures are unavailable.”

The regulatory uncertainty surrounding structured products and OTC derivatives has many investment firms unsure of which products to recommend to their clients. Now, more than ever, advisers and brokers need to justify the investment decisions that they have made. As investors seek ways to manage volatility and increase transparency in the decision-making process, a new product has emerged that is designed to meet these challenges from an independent perspective. Tim Mortimer, Managing Director of Future Value Consultants (FVC), described structurededge.com, a new independent online research and analysis service, as “akin to what Morningstar does for mutual funds.”

“Structured Edge enables you to use objective rankings to find the best and most popular deal types, issuers and underlyings; leverage detailed product reports to better educate your clients and improve transparency; follow new deals and keep abreast in dynamic markets and demonstrate due diligence and provide sound investment advice to your clients,” Mortimer explained.

Get Independent Online Research for the US Structured Products Retail Market

  

 

Access Market Rankings and Breakdowns

 

 

Considered by many registered investment advisors and other investors as ‘the Morningstar equivalent’ for structured products, Structurededge.com is the only online, independent research and analysis resource dedicated to the US OTC derivative and structured products retail market. It offers in-depth reports, rankings and virtual advisor-assisted searches; covering virtually the entire US structured products retail market—across all product types and issuers. Access a replay of the webinar here.

For a free 14-day trial, or to learn more about StructuredEdge.com, contact jjockle@numerix.com.

 

Looking Forward: What Trends Will Impact Model Risk Management in 2012?

As we ring in the New Year, companies are gearing up and looking at several key areas of focus when it comes to effective model risk management in 2012.

We all know that banks’ expanding use of data-driven, quantitative analysis and financial models in most aspects of their financial decision making has escalated the need to manage ‘model risk’ like any other type of risk.  In recent years, as banks have tried and applied financial models to more complex products, we’ve seen that the models themselves can impose risk if they are incorrect, misapplied or misused.

Last year, in response to this new type of risk, and the financial losses associated with it, the Federal Reserve Board (FRB) and Office of the Comptroller of the Currency (OCC) issued the joint Supervisory Guidance on Model Risk Management (OCC Bulletin 2011-12) dated April 4, 2011. According to the OCC, “Model validation remains at the core of the new guidance, but the broader scope of model risk management encompasses model development, implementation, and use, as well as governance and controls related to models.”

Below are the top 10 questions that companies should be asking themselves as they prepare for managing their model risk in the New Year:

1. How would you rank Model Risk as a business risk to your financial institution?
2. Do you have a Model Risk Management Program in place?
3. How often do you assess the data quality and relevance of your models, including tracking and analyzing adjustments to data, assumptions and information and expert judgment?
4. How effective are these data quality controls being run within your organization?
5. How effective are the Model Risk Controls being run by model developers, model owners and model users within your organization?
6. How would you describe your organization’s documentation process?
7. What are some of the controls your organization uses to mitigate Model Risk?
8. What technologies/software do you use to support your Model Risk Program?
9. Does your organization anticipate the need to add more pricing models in the near future?
10. What plans do you have in place to enhance your Model Risk Management policies and practices?

Certainly, all of these questions provide food for thought when it comes to managing your model risk in 2012. If you have further questions, or would like more information about model risk management solutions, please contact sales@numerix.com.

Support Numerix in the 2012 Structured Products Technology Rankings

 Vote Now

We would like to ask for your support in Structured Products Magazine’s 2012 Technology Provider Rankings.  The results showcase the best technology solution providers for the management of structured products.

The survey is divided into several categories, including pricing and analytics, trading systems, market and credit risk management, limits, collateral management, regulatory and economic capital calculation and client interface and e-commerce platform. This link will take you directly to the survey and takes no longer than 5 minutes to complete.

The deadline for responses is Monday, February 6 and the results will appear in the March issue of the magazine.

Thanks for your support!

 Vote Now

Numerix Takes First Place in 2011 Risk Technology Rankings for Credit Valuation Adjustment (CVA) and Structured Products and Cross-Asset Pricing Analytic Categories

 

Numerix today announced that it has won first place in the Risk Magazine Technology Awards 2011 for the individual categories of "Pricing Analytics-Structured Products,” “Cross-Asset” and “Enterprise Risk Management-CVA.”  Risk Magazine polled thousands of banks, hedge funds, pension firms, insurance companies and corporate treasuries for this year's technology rankings.

Numerix also succeeded in gaining top five places in all other pricing & analytics categories in the global poll.  These other categories included: Commodities, Credit, Equities, Foreign Exchange, Inflation and Interest Rate.

The top category wins in this year’s Risk Technology Rankings cap a strong 2011 for Numerix. Read the full press release for more information.

Happy Holidays from all your friends at Numerix!