Correlation Basics: Definitions, Applications and Terminology
Empirical Properties of Correlation: How do Correlations Behave in the Real World?
The Pearson Correlation Model – Work of the Devil?
Cointegration – A Superior Concept to Correlation?
Financial Correlation Modelling – Bottom-up Approaches
Valuing CDOs with the Gaussian Copula – What Went Wrong?
The One-Factor Gaussian Copula Model – Too Simplistic?
Financial Correlation Models – Top-Down Approaches
Stochastic Correlation Models
Quantifying Market Correlation Risk
Quantifying Credit Correlation Risk
Hedging Correlation Risk
Correlation Trading Strategies – Opportunities and Limitations
Credit Value at Risk under Basel III – Too Simplistic?
Basel III and XVAs
Fundamental Review of the Trading Book
The Future of Correlation Modelling
Answers to Questions and Problems in Correlation Risk Modelling and Management
“There is no such thing as free regulation”
– John Hutton
Starting in May 2012, the Basel Committee on Banking Supervision (BCBS) published several papers on the Fundamental Review of the Trading Book (FRTB) proposing major changes to capital requirements for market risk. In 2015 the FRTB was enhanced with the “FRTB-CVA [credit value adjustment] framework” (BCBS 2015). We will discuss this latest version here. The key issues of the FRTB-CVA framework are as follows.
After about 20 years of applying VaR (value-at-risk) with a 99% confidence level and a 10-day horizon, now the expected shortfall (ES) on a 97.5% confidence level for different liquidity time horizons is applied. We will discuss this change in detail below.
Six risk types are determined: (1) equity risk (2) interest-rate risk, (3) foreign-exchange risk (FX), (4) counterparty credit spread risk, (5) reference credit spread risk and (6) commodity risk. For each risk type ES (expected shortfall) has to be derived daily on a 97.5% one-tailed confidence level for different time horizons. ES also has to be derived for a period of significant stress.
The FRTB-CVA framework addresses the credit exposure