Modelling
Many risk and trading applications require the development of models. We have experience of building, selecting and validating models in a wide variety of areas, including:
- Pricing
- Market and credit risk for derivatives and security positions (e.g. VaR, Potential Future Exposure)
- Ratings
- Basel: PD, LGD, EAD
- Economic capital
- Stress testing
All modelling work that we undertake is bespoke to client requirements. We have deliberately not developed our own set of pre-defined models which we sell to clients, as we believe this compromises our ability to develop or find the best available solution. Nevertheless, it will sometimes be more cost and time effective for clients to purchase a vendor solution rather than developing models from first principles. In such circumstances we can assist the client in selecting the vendor that best meets their requirements – see System selection.
Where clients have already developed models but wish to have these independently validated we offer a model validation service.
Client
Private bank/asset manager
Location
Switzerland
Client need
The client acted as investment manager for a number of portfolios containing hedge fund and private equity investments. Gearing was provided against the security of these investments at conservative advance ratios. The client wished to develop a quantitative model to assess the risk in this lending activity and also be able to adjust its lending policy to be more in line with the risk undertaken.
Our deliverables
We developed a model to stress test the portfolio to confirm the adequacy of margins. The model also calculated the advance ratios taking into account the diversification and correlation between assets in the portfolio.
Client type
Private bank/asset manager
Region
Asia
Client need
The client wanted to be able to perform stress tests on its security portfolios to ascertain areas of excessive concentration.
Our deliverables
We developed a stress testing model which took into account asset correlations and liquidity. We also calculated appropriate stress parameters to be input into the model.
Client type
European investment bank
Location
UK
Client need
The client had an ongoing programme for the validation of pricing and risk analytic models. The models within the bank’s fixed interest derivative system were due to be validated, but the documentation for the models and the representation of products within the system was incomplete. The bank needed assistance in developing the validation programme. The products covered ranged from vanilla to exotics.
Our deliverables
Due to the lack of documentation much of the system and the models had to be reverse engineered. Once this had been done we produced a detailed validation plan in line with the client’s own validation policies.
Client type
Wholesale division of European banking group
Location
UK
Client need
The client was in the early stages of considering upgrading its credit risk systems and the methodologies used in the calculation of exposure for its derivatives portfolio. The client wished to have its practices benchmarked against its peers and to have an independent assessment of the strategic direction it should take.
Our deliverables
We conducted a market intelligence study of the bank’s peers covering the methodologies used to calculate credit exposure and the risk systems used.
We benchmarked the client’s methodologies and systems against the market and recommended a strategic direction the bank should follow. This analysis included a comprehensive assessment of the various alternative methodologies, and sample portfolios were analysed under the alternative methodologies.
Client
Major hedge fund manager
Region
UK
Client need
The client needed to develop a methodology for the measurement of credit exposure for certain products (credit and equity related) which could not be handled by its current risk management system. This was required both for limit control purposes and for the measurement of economic capital.
Our deliverables
We developed a methodology for the measurement of potential future exposure and documented this in a methodology paper. We developed a model for the calculation of exposure which the client now uses on an ongoing basis in its business.
Client type
Investment bank and prime broker
Location
UK, US and Germany
Client need
The client had an active business with hedge funds in derivatives, securities financing and prime brokerage. It wanted to satisfy itself that its margin terms were in line with market practice. It was also planning to offer margining on a more sophisticated basis (for example VaR based margining) and wanted to know the practices adopted by its peers in this area and the changes it would need to make to implement a more sophisticated margining approach.
Our deliverables
We conducted a market intelligence survey to ascertain practices within competitor firms. We also surveyed the client’s hedge fund clients to ascertain their views on its margining levels and other aspects of its risk policy and service level.
We benchmarked the client’s current approach against its peers and recommended changes to its policies and methodologies to bring it into line with market practice. We also set out a roadmap for the implementation of more sophisticated margining methodologies.