Reading list FRM 2023.pdf

• Jorion, P.- Value at Risk. The New Benchmark for Controlling Derivatives Risk. ✅ ** C1:“The need for risk management”
• C3: “VAR-Based regulatory capital” ✅
• C5: “Computing VAR” ✅
• C10: “VAR Methods” (except 10.2.3-10.2.5) ✅
• Tufano, P,- Why to manage risk? ✅
• Kester - Introduction to derivative instrument✅
• Lynagh, S., Das, S. (1999). An Overview of Credit Derivatives. ✅
• Das, S. (1998). Citibank Hong Kong – Capital Arbitrage in the Emerging Markets ✅
• BIS (2020): Calculation of RWA for operational risk. Standardized approach. C19: “Operational risk management” ✅
• Cornalba, C., Giudici, P. (2004). Statistical models for operational risk management. Physica A: Statistical Mechanics and its applications, 338(1), pp. 166-172.

a) What is the most important drawback of the historical simulation method when calculating Value-at-risk? (1.5p) The range of possible outcomes is limited by the actual historical market moves, which may not represent the risks posed by future events.

List the two most important advantages and the two most important disadvantages of the delta normal Value-at-Risk calculation method! (2p)

ADVANTAGEs: Simplest method to implement. Speed of calculation.

PROBLEMs: Any departure from a (log)normal distrib. is a problem. The quality of the VAR estimate weakens if the portfolio contains options or other "non-linear" instruments.

When will the Monte Carlo simulation method of estimating VAR produce virtually the same results as delta normal method? List two conditions! (1.5p) When normal distribution is used in the MC simulation. (0.75p) When the MC simulation uses sufficiently large sample. (0.75p)

What are the two key risk factors that needs to be modelled in operational risk management? Along these two key risk factors what is the typical occurrence of the events? (2.5p) Two key risk factors:

1. Frequency of events; (0.5p)
2. Severity of losses due to operational risk events (0.5p) Typical occurrence: High Frequency Low Impact (HFLI) or (0.75p) Low Frequency High Impact (LFHI) - (0.75p)

VAR summarizes the predicted maximum loss (or worst loss) over a target horizon within a given confidence interval. VAR estimations provide information about the potential losses in value for a given position or portfolio, BUT only for a given time period and only for a given level of confidence

Advantages of VAR: • Simple concept • Easily communicated concept • Provides a basis for risk comparison Facilitates capital allocation decisions • Can be used for performance evaluation • Reliability can be verified • Widely accepted by regulators.

Limitations of VAR:

• Non-convex measure: cant add together

• Only short time frames • Misleading in times of high volatility • Failure to consider liquidity. • Endogenous risk = Sensitivity to correlation risk. • Vulnerability to trending or volatility regimes.