There was very interesting and thought provoking content at this year’s conference, with many interesting sessions but too many to catch. Here are a few noticeable themes from the event as well as some interesting topic areas.
- The continual debate about FVA - It was quite interesting to hear John Hull lead a session following up his much talked about 2012 paper on funding value adjustments, titled The FVA Debate. Some of the main discussion points included the significant investment by financial institutions surrounding FVA, which so far has not yielded a uniform consensus or acknowledgement from accounting bodies as to the treatment of FVA. Some ambiguous areas include the challenge in determining appropriate exit value as well as consensus on the approach used by banks. There is varied approaches concerning the inclusion of DVA Funding adjustments. Some likely reasons for this inconsistency is the challenge banks have in incorporating appropriate exit prices in their own funding costs as well as how to effectively include their own funding costs. The inclusion of FVA is a high attention area within banks because of the potential trading book impact and attractive of different derivatives trading strategies. Also mentioned was the increasing interest in repo trades within funding considerations.
- Evolution of quantitative finance – There was an interesting debate on the evolution of quantitative finance and transformation of capital markets where lots of opinion were expressed. There looks to be an evolution to an industry increasingly focused on development endeavors and solving the large technological challenges that remain unsolved with reduced emphasis on pure quantitative modeling of exotics. Some of the biggest industry challenges suggested include aggregate CVA computation, real-time portfolio management, as well as big data management issues. There also may be more structural growth in the buy-side asset manager segment. Some market participants are also seeing a potential product migration to exchanges but there is potential to see technology failures as well as exchange related credit risk, which some see as the next big potential source of default. Both could have potentially crippling impacts on the markets. One of the additional challenges expressed is lack of convergence between regulatory bodies, such as the SEC and the CFTC, in the US which is causing challenges in regulation as well as how to most effectively implement trading and risk decisions.
- Tail risk hedging – The paradigm shift to greater regulatory oversight is resulting in significant changes in the derivatives market place from a regulatory compliance standpoint. This change has resulted in massive change in terms of implementation costs, resourcing, legal, technology, and other areas. These changes have resulted in reductions in certain types of derivatives trading; but on the flip side, there is growing interest in derivatives trades that have potential to reduce regulatory reporting obligations. There has also been a flow into derivative trades that can have favorable treatment to capital requirements and risk reduction strategies such as option strategies that pay off in tail risk events.
- CVA computation challenges abound – CVA is increasingly transforming from a purely quantitative focus in banks to a technology and IT problem. To take one example, add up all simulations by trade, time steps and all netting sets and it turns into a very large computational challenge requiring computational speed - making an efficient pricing library is very important. It also is an area where there’s likely not a single bank that is able to handle wrong-way risk pricing at the bank level, especially when viewing additional computational problems in calibrating and correlating these risk factors. And at the bank level some of the most important analytics concern monitoring, stress testing, and pre-trade conception. Calibration of the model is highly important because simply achieving a CVA number does not imply accuracy for the massive data problem.
- Discussion on different risk measures – There was discussion of the various risk measures, from those being minimized, ones that will become increasingly common, and ones that have had an enduring legacy. In addition to CVA as previously mentioned, VaR (Value at Risk) in its traditional form is increasingly seen as a sub-optimal risk measure in isolation because of some known limitations. There was also discussion about the need for a more comprehensive framework of risk measurement, to one providing effective understanding of risk at complex financial institution. This is also important take-away from the standpoint of regulatory bodies where a more robust risk understanding provides a better framework to evaluate a financial institution’s risk profile as well as reduced opportunity to game different regulatory measures.
It was an interesting few days and the chance to learn about different areas of quantitative finance as well as hear about some interesting trading strategies. Some additional topics included sessions focused on the potential impact of Sovereign Risk through Europe and Asia, increased focus on tightening B/A spreads in the OTC space, modeling liquidity risk and applications of centrally cleared derivatives, effect of cross-margining, the future of exchanges, as well as VIX as a measure in managing equity volatility. Too many topics to take in over the few days there and certainly too many to blog about!