Pre-Trade Risk Analytics: Implied Risk Views, Trade Risk Profiles & Best Hedge Reports
In this piece, we illustrate the use of portfolio implied risk views, trade risk profiles and best hedge metrics to assist traders to manage the risk in their books.
By Carlos Blanco
PASSIVE VS. ACTIVE Risk Management: Many energy trading organizations use VaR limits1
as the primary
market risk control metric. The general rule is that as long as the VaR for a particular risk taking unit is below the VaR limit, no action is required. However, once traders approach their VaR limits, they
are often left to their own devices to manage the risk of their positions. Because of the sometimes complex interactions between the portfolio constituents, traders that do not have access to the right analytical support are operating in the dark when attempting to identify the likely impact on a new trade in the portfolio VaR. Energy firms have made considerable investment in
systems, data and people to produce VaR numbers on a daily basis, but very few of them make effective use of risk analytics to actively manage risk partly because the risk managers’ role in the limit management process tends to be passive and reactive. Fortunately, there are several tools that risk managers can deploy to assist risk takers with the management of VaR limits and maximize risk-adjusted returns used for performance measurement and bonus calculations. Some of the active risk management tools used by leading energy trading organizations include: - Summary of the key sources of risk and interactions of complex portfolios
incremental impact on portfolio VaR when we add an additional dollar of exposure to a given risk factor is positive (negative), then the implied risk view from that position is positive (negative). That means if a trader wants to reduce portfolio risk, the new trade should reduce the long exposure in that particular risk factor with the positive implied risk view rather than adding to the long position. The positions that are most neutral from a risk contribution perspective are those with the smallest absolute implied risk views. Even
though it may be counter-intuitive, the
individual long and short exposures from a volumetric perspective and the implied risk views may sometimes be inconsistent. In some instances, a long position in a given risk factor may be bearish from a portfolio perspective, and a short position may be bullish from a portfolio point of view.
Energy firms have made considerable investment in
systems, data and people ... but very few of them make effective use of risk analytics to actively manage risk
The reason is that the individual exposures fail to
- Decomposition of the risk of a portfolio - Measurement of the incremental impact of a new trade on the overall risk profile and key risk metrics
- Identification of the implied risk views of the portfolio
- Recommendations of optimal hedges based on pre- defined market, credit and liquidity constraints.
Implied Risk Views & Marginal Risk Reports An implied risk view report consists in reverse engineering the portfolio’s individual risk exposures in the context of the overall book. In contrast to simple volumetric reports, the
implied risk view for a given market or risk factor (or a collection of risk factors such as a forward curve) can be interpreted as the impact on the portfolio VaR of adding one additional dollar of exposure in that particular market. Different portfolio exposures have different implied risk views in terms of sign and magnitude. If the
take into account the interactions with the rest of the trading book. As a result, a trader’s individual views on a given market may be different than those implied by the views from his overall portfolio. Figure 1 overleaf shows a risk report with the net dollar exposures, as well as the implied risk views and marginal VaR contribution summarized at the forward curve level. The dollar exposure chart shows the long and short
portfolio positions to each individual market expressed in millions of dollars. We can see that the net longs and shorts are relatively well balanced from a dollar exposure perspective. The portfolio is long WTI, Brent, NYMEX Henry Hub, AECO Gas and NYMEX RBOB and NYMEX Heating Oil. The two net shorts are the exposures to Houston Ship Channel and Socal Natural Gas. Volumetric and dollar exposure reports are useful tools but they have the limitation that they fail to take into account the interaction between portfolio positions. The chart in the middle of Figure 1 shows the implied
risk views. We can see that the NYMEX Natural Gas trades have the largest implied risk views. An implied
March 2013 51
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60 |
Page 61 |
Page 62 |
Page 63 |
Page 64 |
Page 65 |
Page 66 |
Page 67 |
Page 68 |
Page 69 |
Page 70 |
Page 71 |
Page 72 |
Page 73 |
Page 74 |
Page 75 |
Page 76 |
Page 77 |
Page 78 |
Page 79 |
Page 80 |
Page 81 |
Page 82 |
Page 83 |
Page 84