《金融风险管理》课程PPT教学课件（Risk Management and Financial Institutions）Chapter 22 Model Risk

ModelRiskChapter 22RiskManagementandFinanciallnstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 Model Risk Chapter 22 1

Marking the Prices of anInstrument to Market. Use price quoted by market maker(usually financial institutions mark to midof bid and offer) Use price at which financial institution hastraded productUse interdealerbrokerprices Use interdealerprice indications Use model (marking to model2RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Marking the Prices of an Instrument to Market ⚫ Use price quoted by market maker (usually financial institutions mark to mid of bid and offer) ⚫ Use price at which financial institution has traded product ⚫ Use interdealer broker prices ⚫ Use interdealer price indications ⚫ Use model (marking to model) Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 2

AccountingFASB 157 and IASB 39 classify instruments as"held for sale" or “held to maturityThose classified as held for sale have to bemarked to marketLevel 1: uses quoted prices in active marketsLevel 2: uses quoted prices for similar product inactive markets or same product in non-active marketsLevel 3:requires valuation assumptions3RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Accounting ⚫ FASB 157 and IASB 39 classify instruments as “held for sale” or “held to maturity” ⚫ Those classified as held for sale have to be marked to market ⚫ Level 1: uses quoted prices in active markets ⚫ Level 2: uses quoted prices for similar product in active markets or same product in non-active markets ⚫ Level 3: requires valuation assumptions Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 3

Controversial Changes in 2008and2009Banks can in rare circumstances reclassifyinstruments from "held for sale" to "held tomaturity" and vice versaBanks can use model prices in preferenceto market prices when they judge marketprices do not represent fair valueRiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull20124

Controversial Changes in 2008 and 2009 ⚫ Banks can in rare circumstances reclassify instruments from “held for sale” to “held to maturity” and vice versa ⚫ Banks can use model prices in preference to market prices when they judge market prices do not represent fair value Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 4

Model Risk Can Lead To..Incorrect price at time product is bought orsoldIncorrect hedging5RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 Model Risk Can Lead To. ⚫ Incorrect price at time product is bought or sold ⚫ Incorrect hedging 5

Finance vs Physics (page 476) The models of physics describe physicalprocesses and are highly accurate. Theirparameters do not change through time.The models of finance describe humanbehavior. They are at best approximations.Parameters do change through time6RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 Finance vs Physics (page 476) ⚫ The models of physics describe physical processes and are highly accurate. Their parameters do not change through time. ⚫ The models of finance describe human behavior. They are at best approximations. Parameters do change through time 6

CalibrationModels of finance are calibrated to marketprices daily As a result parameters change from day today For a particular option maturing in threemonths volatility might be 20% on Day 122% on Day 2, and 19% on Day 3.7RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 Calibration ⚫ Models of finance are calibrated to market prices daily ⚫ As a result parameters change from day to day ⚫ For a particular option maturing in three months volatility might be 20% on Day 1, 22% on Day 2, and 19% on Day 3. 7

TheWayModelsAreUsuallyUsedin FinanceObservemodel pricesforsimilarinstrumentsthattradeImplymodelparametersInterpolateas appropriateValuenewinstrumentRiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull20128

The Way Models Are Usually Used in Finance Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 8 Observe model prices for similar instruments that trade Imply model parameters. Interpolate as appropriate Value new instrument

LinearProducts Very little uncertainty about the right modelBut mistakes do happen. For example..Kidder Peabody (Business Snapshot 22.1page 476)LIBOR-in Arrears Swaps (Business Snapshot22.2, page 477)9RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull2012

Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 Linear Products ⚫ Very little uncertainty about the right model ⚫ But mistakes do happen. For example. ⚫ Kidder Peabody (Business Snapshot 22.1, page 476) ⚫ LIBOR-in Arrears Swaps (Business Snapshot 22.2, page 477) 9

Standard Products We do not need usually a model to knowthe price of an actively traded product. Themarket tells us the price.The model is a communication tool (e.g.,implied volatilities are quoted for options)It is also an interpolation tool (e.g., a toolfor interpolating between strike prices andmaturities.RiskManagementandFinancialInstitutions3e,Chapter22,CopyrightJohnC.Hull201210

Risk Management and Financial Institutions 3e, Chapter 22, Copyright © John C. Hull 2012 Standard Products ⚫ We do not need usually a model to know the price of an actively traded product. The market tells us the price. ⚫ The model is a communication tool (e.g., implied volatilities are quoted for options) ⚫ It is also an interpolation tool (e.g., a tool for interpolating between strike prices and maturities. 10