New dynamic risk measure launched

Speaking at the Energy Risk Europe conference in London, Andrea Roncoroni, professor of finance at the ESSEC Business School in Paris and Singapore, presented a new method to widen the extent of any risk measure and capture the time evolution of market risk for energy and commodity linked positions.

A 'flowing value-at-risk', or FloVaR, has been developed by Roncoroni in collaboration with Gianluca Fusai, professor of finance at Piemonte Orientale University, and Rachid Id Brik, a PhD student at Paris Dauphine University. This tool provides the user with an estimation of a company’s  global exposure to market risk over a period of time.

The underlying concept is to take into account future cashflows and derive a risk assessment path indicating the expected future variations of VAR at selected levels of confidence.

Inputs of the model are the company’s proprietary information, consisting of active deals and market data, including energy and commodity spot prices, forward curves and counterparty credit spreads.

FloVaR is obtained by computing a multivariate factor analysis that keeps track of seasonality patterns and cross-dependence over a set of underlying commodity prices.

The advantage of this approach compared to static measures of risk is that it allows companies to optimise the timing of hedging decisions and liquidity management.

Professor Vincent Kaminski of Rice University’s Jesse Jones School of Business, who spoke earlier on illiquidity in energy markets at the same conference, welcomed Roncoroni’s presentation. “A framework that gives the time evolution of risk is a creative idea that could be a useful tool for small-to-medium sized energy companies,” he said.

As Roncoroni points out, FloVaR is likely to be suitable for small- and medium-sized energy firms that do not have the resources to develop a model for risk management internally.

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• Topics
• Energy trading
• Risk management
• Vince Kaminski
• Risk management
• Market risk