The role of simulation in risk management and decision support A Simulation is a simplified imitation of a process or system that represents with some fidelity its operation over time. In the context of risk management and decision support simulation can be a very powerful tool as it allows us to assess potential outcomes in a systematic way and explore what-if questions in ways that might otherwise be not feasible. Simulation is used when the underlying model is too complex to yield explicit analytic models (An analytic model is one can be “solved” exactly or with standard numerical methods, for example resulting in a formula).
Federated Credit Systems, Part I: Unbundling the Credit Provision Business Model: As an architectural design and information technology approach, federation has received increased attention in domains such as the medical sector (under the name federated analysis), in official statistics (under the name trusted data) and in mass computing devices (smartphones), under the name federated learning. In this (the first of series of three) white paper, we introduce and explore the concept of federated credit systems.
Course Content: This course is an introduction to the concept of credit contagion. It covers the following topics: Contagion Risk Overview and Definition Various Contagion Types and Modelling Challenges The Simple Contagion Model by Davis and Lo Supply Chains Contagion Sovereign Contagion Who Is This Course For: The course is useful to: Risk Analysts across the financial industry and beyond Risk Management students Quantitative Risk Managers developing or validating risk models How Does The Course Help: Mastering the course content provides background knowledge towards the following activities:
Connecting the Dots: Economic Networks as Property Graphs: We develop a quantitative framework that approaches economic networks from the point of view of contractual relationships between agents (and the interdependencies those generate). The representation of agent properties, transactions and contracts is done in the a context of a property graph. A typical use case for the proposed framework is the study of credit networks. You can find the white paper here: (OpenRiskWP08_131219)
The motivation for federated credit risk models: Federated learning is a machine learning technique that is receiving increased attention in diverse data driven application domains that have data privacy concerns. The essence of the concept is to train algorithms across decentralized servers, each holding their own local data samples, hence without the need to exchange potentially sensitive information. The construction of a common model is achieved through the exchange of derived data (gradients, parameters, weights etc).
Limit frameworks are fundamental tools for risk management: A Limit Framework is a set of policies used by financial institutions (or other firms that actively assume quantifiable risks) to govern in a quantitative manner the maximum risk exposure permitted for an individual, trading desk, business line etc. Why do we need limit frameworks? A limit framework is expressing in concrete terms the Risk Appetite of an institution to assume certain risks.
The challenge with historical credit data: Historical credit data are vital for a host of credit portfolio management activities: Starting with assessment of the performance of different types of credits and all the way to the construction of sophisticated credit risk models. Such is the importance of data inputs that for risk models impacting significant decision making / external reporting there are even prescribed minimum requirements for the type and quality of necessary historical credit data.
Release of version 0.4.1 of the transitionMatrix package focuses on stressing transition matrices: Further building the open source OpenCPM toolkit this realease of transitionMatrix features: Feature: Added functionality for conditioning multi-period transition matrices Training: Example calculation and visualization of conditional matrices Datasets: State space description and CGS mappings for top-6 credit rating agencies Conditional Transition Probabilities The calculation of conditional transition probabilities given an empirical transition matrix is a highly non-trivial task involving many modelling assumptions.
Release of version 0.4 of the transitionMatrix package: Further building the open source OpenCPM toolkit this realease of transitionMatrix features: Feature: Added Aalen-Johansen Duration Estimator Documentation: Major overhaul of documentation, now targeting ReadTheDocs distribution Training: Streamlining of all examples Installation: Pypi and wheel installation options Datasets: Synthetic Datasets in long format Enjoy!
Credit Portfolio PnL volatility under IFRS 9 and CECL: Objective We explore conceptually a selection of key structural drivers of profit-and-loss (PnL) volatility for credit portfolios when profitability is measured following the principles underpinning the new IFRS 9 / CECL standards Methodology We setup stylized calculations for a credit portfolio with the following main parameters and assumptions: A portfolio of 200 commercial loans of uniform size and credit quality Maturities extending from one to five annual periods A stylized transition matrix producing typical multiyear credit curves Correlation between assets typical for a single business sector and geography portfolio Focusing on PnL estimates one year forward, with PnL being impacted both by Realized Losses (defaults) and Provision variability (both positive and negative).
Credit Portfolio Management in the IFRS 9 / CECL and Stress Testing Era: The post-crisis world presents portfolio managers with the significant challenge to asimilate in day-to-day management the variety of conceptual frameworks now simultaneously applicable in the assessment of portfolio credit risk: The first major strand is the widespread application of regulatory stress testing methodologies in the estimation of regulatory risk capital requirements The second major strand is the introduction of new accounting standards (IFRS 9 / CECL) for the measurement and disclosure of expected credit losses
The new IFRS 9 financial reporting standard: IFRS 9 (and the closely related CECL) is a brand new financial reporting standard developed and approved by the International Accounting Standards Board (IASB). Strictly speaking IFRS 9 concerns only the accounting and reporting of financial instruments (e.g. bank loans and similar credit products). Yet the introduction of the IFRS 9 standard has significant repercussions beyond financial reporting, and touches e.g., bank risk management as well.
What are European Safe Bonds? While the creation of the eurozone was a landmark of the European integration process, the financial crisis highlighted that the eurozone remains an incomplete design which can lead to unpredictable and adverse situations in the event of a (the) next major crisis. One of the key such incompleteness features of the current eurozone architecture is that it does not have a truly risk-free (safe) euro debt instrument: one that continues being serviced (avoids a default event) at virtually any point in time and state of the world, no matter how severe.
Release of version 0.3 of the Concentration Library: Further building out the OpenCPM set of tools, we release version 0.3 of the Concentration Library. This python library for the computation of various concentration, diversification and inequality indices. The below list provides documentation URL’s for each one of the implemented indexes Atkinson Index Concentration Ratio Berger-Parker Index Herfindahl-Hirschman Index Hannah-Kay Index Gini Index Theil Index Shannon Index Generalized Entropy Index Kolm Index The image illustrates a simple use of the library where the HHI and Gini indexes are computed and compared for a range of randomly generated portfolio exposures.
Motivation for Building an open source database based on EBA’s Standardized NPL Templates In a recent insightful piece “Overcoming non-performing loan market failures with transaction platforms”, Fell et al. dug deeply into the market failures that help perpetuate the NPL problem. They highlight, in particular, information asymmetries and the attendant costs of valuing NPL portfolios as key obstacles. In the same wavelength, the European Banking Authority published standardized NPL data templates as a step towards reducing the obstacles that prevent the reduction of NPL’s.
Open Risk released version 0.1 of the Transition Matrix Library Motivation: State transition phenomena where a system exhibits stochastic (random) migration between well defined discrete states (see picture below for an illustration) are very common in a variety of fields. Depending on the precise specification and modelling assumptions they may go under the name of multi-state models, Markov chain models or state-space models. In financial applications a prominent example of phenomena that can be modelled using state transitions are credit rating migrations of pools of borrowers.
The Zen of IFRS 9 Modeling: At Open Risk we are firm believers in balancing art and science when developing quantitative risk tools. The introduction of the IFRS 9 and CECL accounting frameworks for reporting credit sensitive financial instruments is a massive new worldwide initiative that relies in no small part on quantitative models. The scope and depth of the program in comparison with previous similar efforts (e.g. Basel II) suggests that much can go wrong and it will take considerable time, iterations, communication and training to develop a mature toolkit that is fit-for-purpose.
Reducing variation in credit risk-weighted assets - The benign and vicious cycles of internal risk models: March 2016 wasn’t a good month for so called internal risk models, the quantitative tools constructed by banks for determining such vital numbers as how much buffer capital is needed to protect the savings of their clients. First came the Basel Committee’s proposed revision to the operational risk capital framework applicable to banks, next came a similarly fundamental overhaul of what form of risk quantification will be acceptable for calculating credit risk capital requirements.
Risk Capital for Non-Performing Loans: Currently many countries are drowning in bad credits This visualization from the World Bank shows the current distribution of non-performing loans (NPL’s in short) around the world, as fraction of the total outstanding loans: Translated in absolute numbers (according to IMF data) the European NPL book alone stands at around 1 trillion EUR. As the adage goes, a trillion here, a trillion there, you pretty soon talk about serious money
FX Lending Risk: A stress testing methodology for analyzing FX lending risk. Extends standard credit risk modelling tools to capture the increased risks of FX lending in a consistent way Financial Weapons of Mass Destruction Warren Buffet famously declared financial derivatives as weapons of mass destruction (although apparently this did not prohibit him from using them when convenient). The leverage afforded by such contracts, their potential complexity, or simply their novelty which may imply lack of understanding, are some reasons why one would classify them as potential contributors of systemic risk, which is a polished rephrasing of the more popular this sucker is going down quote.