Market Risk Data Flow
Effective market risk management requires all markets risks to be appropriately identified, measured and controlled. Market risk itself is defined as the potential (adverse) change in portfolio value from changes in the market inputs. A well-functioning risk control process reflects the foundational role of valuation and the direct linkage with risk from end-to-end with appropriate control points and feedback loops.
In the Risk Measurement Data Flow, positions are valued using models and market inputs. The valuation process is enhanced via Independent Price Valuation (IPV), Valuation Adjustments (VA) and proxy bookings. The valuation process then feeds profit and loss (P&L) and Risk which can be connected through the P&L Attribution (PAA). Market risk measures and diagnostics, such as VaR, are an outcome from the risk measures. This forms the cornerstones of the Market Risk Measurement Management and Data Review Process.
A comprehensive P&L attribution will need to incorporate a quantification of unexplained P&L and P&L from non-market factors. However, the differences between P&L attribution excluding these factors and P&L measured through risks should be minimized.
VaR represents a critical risk model which requires governance around Risks not in VaR (RNIV). RNIV are market factors driving P&L which are not captured in the VaR model. Performance of the VaR model can be evaluated through backtesting by comparing the model’s risk measures and actual trading outcomes.
The Market Risk Measurement and Data Review needs to consider all potential risk measurement and data process gaps during the life cycle of a trade in the risk system. From inception, when a trade is first executed, the trade needs to be modelled and captured accurately in the risk system. This includes capturing the appropriate market data and market factor sensitivities for the specific trade. Additionally, all market factors driving valuation need to be modelled in the VaR system. Thus the process will comprise five review streams to connect the necessary valuation, risk measurement and risk capture processes.
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