A Risk Professional's Survival Guide: Applied Best Practices in Risk Management

CHAPTER 12 Market Risk Hedging

OVERVIEW

In Chapter 10, the Trading Services Department (TSD) is noted for its proprietary trading activities in fixed-income instruments and bank equities. The trading activities of this group are monitored by SifiBank’s Corporate Risk Office, which has established a set of position limits and VaR tolerances for the company that it expects to be followed by each of the divisional and departmental risk offices. The sole purpose of TSD is to take positions in various investments in order to generate a profit for the bank. In this regard TSD’s objectives are quite different from other divisions that trade on behalf of customers or are market makers. These entities do not wish to take a particular view of the market and thus rely on various hedging strategies to maintain a neutral position. For TSD, hedging is a strategy for maintaining the portfolio’s risk tolerance within the stated daily VaR limit.

TSD’s head of risk management was hired by the head of TSD several years earlier, as both had worked together in TSD, where the risk officer had been one of the better traders on the desk. The primary oversight of TSD’s activities, including adherence to VaR and position limits, is by the TSD risk office. This group develops its own VaR models for TSD and applies the 99 percent confidence level daily VaR tolerance established by SifiBank risk management to the TSD portfolio. The TSD Risk Committee reviews the VaR on a monthly basis, although management ...