Market Risk for

Financial Risk Management FRM

Part-2
By Shivgan Joshi
http://stockcreditfinancecfa.blogspot.in/
Disclaimer
All terms like FRM are copyright to GARP
Institute
This video is intended to learning, research
and reporting about FRM Exam
I dont represent FRM Institute, Nor I am
authorized trainer or endorsed by GARP/FRM
I dont claim or guarantee accuracy of the
information

About the Author
Instructor has 70% score on BAT, in aprox top 90
percentile globally
Cleared CFA L1, FRM L1 exams
Have experience of teaching on Wiziq, taking
classes on GRE and GMAT for the past 1 year

Websites
www.freegregmatclass.com
stockcreditfinancecfa.blogspot.in

Quant Topics (Part 1/2)
Copula
EVT
Exotic Options
Implied Volatility for Black Scholes
Maximum likelihood


Continued from Part 1
Parametric vs Non-parametric Methods
Delta normal VAR
Lognormal VAR: VAR=P(t-1)*(1-e^(Ur-
Sigmar*Za)
Coherent Risk Measure: Gives Weight to
quantiles (1/(1-confidence-level))
Historical Non Parametric estimations
Weighted Historical Simulation


Quantile Quantile Plots
Used to find out if the Assumed distribution is
close to the real data
Linear lines close to the data points depicts
perfect match


Wiki
Copula
F(x,y)=C(u,v)
F(x)=u and F(y)=v: marginal functions
Function that joins a multivariate function to a
collection of univariate marginal distribution
functions
Gaussian copula: Depends on correlation coefficient
p.
Gumbel copula: beta
Archimedean copula: generator function
Extreme Value copula


Parametric Approach Advanced
Extreme value theory (EVT): three parameters, ><= 0
Peaks over Threshold approach: defines random variable X
to be loss
Maximum likelihood estimate: is a method of estimating
the parameters of a statistical model
Generalized Pareto distribution
Comparing all parametric methods

http://en.wikipedia.org/wiki/Maximum_likelihood
http://en.wikipedia.org/wiki/Extreme_value_theory

POT Formula
Var
Es

Back testing VAR & VAR Mapping
for Stress tests
Failure Rates in Model Verification
Increasing k capital requirement multiplier if instance
crosses the limit
Log-likelihood error formula to accept or reject the tail
points
BASEL Rule for back testing, 2.5 exception and increase of
capital multiplier k
Conditional Coverage: LRcc=Lruc+LRind
Price sensitivity for Parallel Yield
Fixed Income instruments: Different durations, convexities,
etc

Fixed Income
Key Rate Shifts: Effect on rates based on spot
rates (multi factor approach)
Science of term structure Models
Multi factor Hedging
Yield curves
Different durations and interpretations
Binomial Model for Interest rates using
Binomial tree

Convexity Formulas
Convexity




Convexity for Zero
2
y y O
O
BV BV BV
BV
A +A
+
2
( 0.5)
1
2
T T
y
+
| |
+
|
\ .
Volatility Smiles
Implied Volatility from Black Scholes model
Put Call Parity
Currency Options
Equity Options
Option Greeks
Price Jumps

Exotic Options
11 Exotic Options
Binary options

Volatility Variance swaps


MBS
SMM CPR
Valuation: Monte carlo
Option Adjusted Spread, zero volatility, and
option cost

Null Hypothesis

Conclusion
Overview of Market Risk Syllabus of FRM L2
References
FRM Readings