Insights
CMRA Books and Resources
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CMRA Commentary
The Volatility market move yesterday was unprecedented: an increase of 177% from 23.68 to 65.7. The spike was reversed intraday and the VIX closed at 38.57.
Extreme fluctuations like what we saw in the VIX yesterday create significant gains for some and significant losses for other clients.
The inverted yield curve upended several banks. What will the inevitable snap-down do?
The US Treasury yield curve has now been more inverted for longer than at any time since at least the early 1980s, or when measured proportionately, for even longer. The US is now one of 36 countries with inverted yield curves, as central banks globally fight inflation. It is often said that inverted yield curves predict recession, but in fact they predict (with confidence) falling rates. Sometimes, falling rates are associated with recession, but that need not always be the case.
The volatility of the VIX Index has at times caused the impression that it is less than reliable as an indicator of risk. VIX futures and the volatility surface provide clearer information about the market perception of risk and should be used in conjunction with the VIX Index. The different movements of the VIX Index, VIX futures and of the volatility surface historically fall into four major categories that can be useful in understanding the level and length of equity market risk perceived in the options market.
With supply chain pressures, inflation, a possible recession, and a war, it is not surprising that options prices and implied volatility are up. It's like déjà vu all over again. As senior practitioners at Capital Market Risk Advisors (CMRA) with more than 30 years’ experience each, we’ve seen this movie before. Those who don’t learn from history are forced to repeat it.
As a quant who studied AI in the early 70’s and morphed into a derivatives pioneer/risk manager/ risk advisor, this article re quant funds in China attracted my attention. Several important points that we all know but sometimes need to be reminded:
1. “Say what you do and do what you say” is an essential component of the responsibility an asset manager owes to their investors that is not always respected
2. History does not always repeat itself nor should we assume it will
3. It is important to stress test how sensitive your conclusions are to your assumptions in addition to sensitivity to market moves
4. Liquidity matters and changes over time. Beware of “iceberg risk” where your positions might have copycats that impact your liquidity
We are pleased to announce that Peter Niculescu, partner of CMRA, has been invited as a keynote speaker at The Quant Conference Digital on November 6th, 2020. The Quant Conference is one of the largest quant conferences engaging the foremost thought leaders from finance and academia to discuss the future of the quantitative finance industry. The Quant Conference Digital is the first visual event and covers topics including “Legends of The Industry on The Role of AI in The Future of Investment Management", a keynote on "Risk manager versus virus", a panel on "The Age of Quant: Persistent Returns or Never-Ending Arms Race?" and much more.
Every crisis is an opportunity to learn and grow. Although history does not necessarily repeat itself, risk management flaws and weaknesses often do. To avoid making the same mistakes again, it is useful to reflect on lessons learned and in many cases re-learned.
To that end, we have conducted a survey of a select group of risk management professionals to tease out their reactions and conclusions to the events of 2020.
Liquidity risk is a key risk and has been a recent focal point for regulators, with increasing transparency and attention demanded by SEC Rule 22e-4 for mutual funds and by Basel III's liquidity requirements for banks. Meanwhile, market participants have a sense that asset liquidity may be deteriorating, but there is little agreement even on the definition of liquidity risk or on how exactly to measure it. It is clear, however, that asset liquidity risk is multifaceted and managing it is both an art and a science.
We explore some of the questions surrounding asset liquidity risk in our whitepaper.
Lehman Brothers filed for bankruptcy on September 15, 2008 and the subsequent Great Recession reached its peak in 2009. Because these were the biggest and most stressful financial events of the last 80 years, historical data from 2008 and 2009 form the basis for much of today’s risk stress testing. However, as the intervening years push us further away from 2008 and 2009, the Great Recession’s impact on risk metrics can start to recede.
Most financial services companies use stress scenarios that are based on historical data. For example, the 99th percentile adverse move over a 10-day period is a common cut-off for the development of stress scenarios. Notably, such a stress scenario is by definition no more severe than the 99th percentile.
CMRA Interviews and Press
“Risk managers are supposed to rely on hard data, but what happens when a gut feeling is more accurate? A new note from consultants at Capital Market Risk Advisors (CMRA) suggests that one of the big lessons of the covid era is that risk managers should follow their hunches even if the data hasn't caught up yet.
Interviews with risk managers conducted by CMRA suggest that while markets were aware of a potential threat from the coronavirus in January, few risk models took it seriously. The threat was vague and hard to quantify, which meant risk managers put off doing stress tests that considered its potential impact until it was almost too late […]
It's not enough to include updated volatility in models, instead, risk managers should be stress testing every day until markets return to calm […] CMRA notes that risk models rely on correlations within historical data. Volatile markets provide the precise environment to ensure that historical risk models are still valid. Testing during volatility may also unearth new historical correlations and risk insights that can prove valuable to portfolio management going forward.”
"Citigroup Inc. and the wreckage of Lehman Brothers Holdings Inc. have resolved a fight over $2.1 billion that dates to the financial crisis, while quietly burying a key question about derivatives-trading practices.
Citigroup agreed Friday that it will give back $1.74 billion to the estate of the failed New York-based investment bank. Citigroup had kept about $2.1 billion that Lehman had on deposit with it for trades on everything from interest rates to corporate and sovereign debt at the time of the 2008 bankruptcy [...]
He said there was hope it would bring a legal opinion on issues like bid-ask spreads, netting or combinations of trades, and whether counterparties are entitled to the cost of replacing trades even if they don’t actually replace them.
'It would have been nice to get clarity from a judicial process,' Niculescu said in a phone interview. He noted that a public ruling could have a big downside for both Citigroup and Lehman, however; for Citigroup, it could affect current trading practices, and for Lehman, it could set a precedent for how it would settle remaining claims"
Lexis PLS Banking & Finance analysis: Capital Market Risk Advisors (CMRA) has surveyed market participants about the new variation and initial margin requirements. Leslie Rahl and Peter Niculescu, partners at CMRA and members of the P.R.I.M.E. Finance Panel of Experts outline the responses on this topic and highlight the potential benefits and costs of implementing the new regulations and explain that while the new regulations seek to reduce both systemic risk and counterparty risk, they likely will not significantly curtail future legal disputes surrounding derivatives closeout.
The expert analysis and testimony prepared by Capital Market Risk Advisors (CMRA) - a leading risk management, risk governance, and litigation support boutique for the past 25 years - was extensively cited in a 524-page judgement dismissing all 187 claims, with almost $2 billion in alleged damages at stake, against Carlyle Capital Corporation Ltd's directors in a case involving leveraged RMBS.
“The parties seem pretty far apart in their perceptions of the value of the claim,” Peter Niculescu, a partner at Capital Market Risk Advisors who has worked on previous Lehman settlements, told me. “There did not seem to be from the public docs any likely avenue to reconcile their perceptions.” [...]
Lehman’s industry agreement, which required participating banks to net along strict and agreed-upon guidelines, could be an indication. “It’s not the law, but it does contain the imprimatur of commercial reasonableness given how many have agreed to it,” Niculescu said.
But a judgment with Citi would create a different precedent. “The question is how to resolve a settlement dispute involving a variety of derivatives with the non-defaulting counterparty [Citi] would never have intended to replace, and whether they should be valued at a line-item replacement cost or whether true economic replacement costs mean something different,” Niculescu said.
Helpful Web Resources
Associations & Organizations
- Alternative Investment Management Association (AIMA)
- Managed Funds Association (MFA)
- Securities Industry and Financial Markets Association (SIFMA)
- Financial Accounting Standards Board (FASB)
- Financial Stability Board
- Global Association of Risk Professionals (GARP)
- Global Risk Institute (GRI)
- International Association for Quantitative Finance (IAQF)
- International Swaps and Derivatives Association (ISDA)
- P.R.I.M.E. Finance
- Professional Risk Manager’s International Association (PRMIA)
Derivatives
- BIS Semiannual derivatives statistics
- Volume data for over-the-counter derivatives
- ISDA SwapsInfo
- Visualize over-the-counter derivatives data
- OCC Quarterly Report on Bank Derivatives Activities
- Quarterly report on bank and bank holding company derivative activities
Periodicals
- Bloomberg Markets Magazine
- Euromoney
- Financial Times
- Matt Levine's Money Stuff
- A daily newsletter highlighting the latest news and developments in all things finance, delivered with a healthy dose of humor.
- The Wall Street Journal
Risk Management
- Federal Reserve Economic Data (FRED)
- NYU Stern Volatility Laboratory
- Research on risks in financial markets, with daily calculations of volatilities and correlations on a wide range of assets
- Risk.net
- Coverage of financial industry, with a focus on risk management, derivatives, and complex finance
Regulatory
- Commodity Futures Trading Commission (CFTC)
- Federal Deposit Insurance Corporation (FDIC)
- Federal Housing Finance Agency (FHFA)
- Federal Reserve Board (Fed)
- Financial Industry Regulatory Authority (FINRA)
- National Futures Association (NFA)
- Office of the Comptroller of the Currency (OCC)
- U.S. Securities and Exchange Commission (SEC)
Structured Finance
- Asset Securitization Report
- Coverage, analysis, and commentary on structured finance markets
- Structured Finance Industry Group
- Educational resources on structured finance and securitization
- The Journal of Structured Finance
- Quarterly academic journal on structuring and investing in structured finance.
CMRA Books
Risk Management for Institutional Investors:
Fulfilling Fiduciary and Strategic Responsibilities
By Richard Horwitz and David Tyson, Capital Market Risk Advisors; Published by Risk Books, Nov 2013
More about the book
Risk Management for Institutional Investors: Fulfilling Fiduciary and Strategic Responsibilities addresses how board members, directors, trustees, and members of the C-suite overseeing a pension or endowment fund can properly manage and mitigate risk. It details on a practical level how the necessary data can be collected and reported to this governing board within the broad framework of current risk management practices.
This holistic executive report will include discussions of risk appetite, risk governance, board risk communication, and board risk training, and will address how highly technical and granular data can be synthesized so that it can be reported to a board that may only meet for three hours every three months, in turn informing the decisions the institutional investors make.
Risk Budgeting, Second Edition:
Risk Appetite and Governance in the Wake of the Financial Crisis
Edited by Leslie Rahl, Capital Market Risk Advisors
More about the book
- This fully updated and revised second edition of the best-selling guide Risk Budgeting expands upon the first edition, continuing to provide a road map for more effective risk allocation and better return per unit of risk taken. This edition reflects in particular the growing focus on risk appetite and governance in the risk budgeting environment.
Hedge Fund Transparency:
Unraveling the Complex and Controversial Debate
By Leslie Rahl, Capital Market Risk Advisors
More about the book
The only title that focuses solely on hedge fund transparency and offers a balanced perspective that appreciates both the needs of institutional investors and hedge fund managers.
Presents clear insight on why hedge fund transparency is an issue, as well as offers solutions
- Includes "perspectives" based on interviews with numerous eminent practitioners from both sides of the investor/hedge fund debate
- Service providers including consultants, prime brokers, third party marketers, capital introducers, systems providers, lawyers and accountants, will additionally acquire an enhanced insight into the needs of both investors and hedge funds in order to tailor their services to the market needs
- The press and the regulators can also achieve enhanced understanding of this complex and controversial subject
- Written by the best-selling author and practitioner Leslie Rahl, who is the chair of the Investor Risk Committee of the IAFE Committee on Hedge Fund
- Transparency and is uniquely placed to advise on and explain the issues for all concerned participants
Risk Budgeting
A New Approach to Investing
Edited by Leslie Rahl, Capital Market Risk Advisors; Published by Risk Books, November 2000
More about the book
A practical and authoritative introduction to the concept of risk unit allocation as an alternative and more effective decision-making process for long-term investors.
Make an informed decision about how to implement and execute a "risk unit allocation" investment policy
- Analysis of techniques to assess how risk might impact long-term Investment returns
- Introduces methods to allocate assets based on the "risk unit" exposures - in individual asset classes and on a portfolio basis, to meet long-term pension obligations and investment return objectives
- Investigates ways to use VAR to accommodate a long-term investment horizon
- Contributions from leading experts drawn from consultancies; large institutional investors; pension plans; investment banks and academia
- Leslie Rahl has donated her proceeds from the sale of the book to the Fischer Black Memorial Foundation.
Hedge Fund Risk Fundamentals:
Solving the Risk Management and Transparency Challenge
By Richard Horwitz, Capital Market Risk Advisors
More about the book
In the constantly evolving hedge fund marketplace, nothing is more central--but in many ways, more amorphous and elusive--than risk. Yet there remains no standard for analyzing and measuring risk within this highly secretive, largely unregulated field, leaving the thousands of hedge funds--and the tens of thousands of hedge fund investors--in dangerously dim light. The industry has not solved the "transparency" challenge--communicating risk to investors without disclosing proprietary information.In the constantly evolving hedge fund marketplace, nothing is more central--but in many ways, more amorphous and elusive--than risk. Yet there remains no standard for analyzing and measuring risk within this highly secretive, largely unregulated field, leaving the thousands of hedge funds--and the tens of thousands of hedge fund investors--in dangerously dim light. The industry has not solved the "transparency" challenge--communicating risk to investors without disclosing proprietary information.
Hedge Fund Risk Fundamentals is the first book to bring these issues to the forefront. With clarity, concision, and minimal math, Richard Horwitz lays out the key components and the cutting-edge processes in the field of hedge fund risk management today. Against that backdrop, he presents a groundbreaking utility destined to set the standard for transparency and risk management within the hedge fund universe.
You’ll learn why, when it comes to risk management, 1 + 1 = 1.41. For all of those perplexed by the difficulties of assessing risk in hedge fund investing, Horwitz’s concepts make for an invaluable road map and a demystifying resource that hedge funds and investors at all levels will find indispensable.
Value at Risk
"This book has become an industry standard for value at risk."
Leslie Rahl, president, CMRA
More about the book
- To accommodate sweeping global economic changes, the risk management field has evolved substantially since the first edition of Value at Risk, making this revised edition a must. Updates include a new chapter on liquidity risk, information on the latest risk instruments and the expanded derivatives market, recent developments in Monte Carlo methods, and more. Value at Risk, Second Edition, will help professional risk managers understand, and operate within, today's dynamic new risk environment.
How I Became a Quant
By Richard R. Lindsey and Barry Schachter
From Amazon:
More about the book
"Quants"--those who design and implement mathematical models for the pricing of derivatives, assessment of risk, or prediction of market movements--are the backbone of today's investment industry. As the greater volatility of current financial markets has driven investors to seek shelter from increasing uncertainty, the quant revolution has given people the opportunity to avoid unwanted financial risk by literally trading it away, or more specifically, paying someone else to take on the unwanted risk.
How I Became a Quant reveals the faces behind the quant revolution, offering you the chance to learn firsthand what it's like to be a?quant today. In this fascinating collection of Wall Street war stories, more than two dozen quants detail their roots, roles, and contributions, explaining what they do and how they do it, as well as outlining the sometimes unexpected paths they have followed from the halls of academia to the front lines of an investment revolution.
Risk Management: The State of the Art
Edited by Stephen Figlewski and Richard M. Levich
More about the book
The articles in this volume examine the "State of the Art" in risk management from the standpoint of academic researchers, market analysts and practitioners, and government observers with
Risk Management: Where Are We Heading? Where Have We Been? Contributed by Leslie Rahl.
The expert analysis and testimony prepared by Capital Market Risk Advisors (CMRA) - a leading risk management, risk governance, and litigation support boutique for the past 25 years - was extensively cited in a 524-page judgement dismissing all 187 claims, with almost $2 billion in alleged damages at stake, against Carlyle Capital Corporation Ltd's directors in a case involving leveraged RMBS.