Risk Magazine article: How B2.5 beached the London Whale
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gill
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Risk Magazine article: How B2.5 beached the London Whale
I skimmed the article and found nothing wrong there. Specifically whats wrong there?
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polysena
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Risk Magazine article: How B2.5 beached the London Whale
Dear Cheng,
My ??? in the reading was precisely the explaination of interaction with the "market strategy" and the RWA, I am not sure it works (at least for me). The RWAs in this area [if you count out the cap charges from usual VAR, and stressed Var-new with B2.5]..are the result of the maximum of two charges (A;B). The charge A: is determined by an internal modelling approach "usually labelled a CRM model". Basically A: is the max between a 12 weeks running window (t_12,..t_0) of "CRM" model charge and the charge for t_0.
The charge B "deemed a standardized floor" is obtained through taking 8% of a standardized capital charge which is obtained itself as a maximum of net longs and net shorts in the same window fashion as defined above. The capital charges in the standardized approach are to be applied to nontranched and tranched positions. For tranched positions: I believe that by utilisation of securitisation framework approaches- the SFA would be probably candidate/or concentration ratio approach (most probably the latter because US bank not fully B2)- because typically tranched Indices aren't rated. Of course the floor is not static, it fluctuates.
Concentration ratio works like that you look through the underlying pool and determine a standardized capital charge, then you compute a concentration factor i.e. total over sum of all tranches' width junior or pari passu to the one you are considering,- ie the junior CDX would have a cr=100/15=6.7 and the senior tranche attaching at 35 cr=1. Charge is then cr*charge of the pool. So a minimizing RWA strategy would have to try to use higher tranches more.
By construction it is quite clear that in some cases- tbd-, the RWAs are determined by the floor (=ceiling) and in other cases they would be defined by the "model" (sorry for this tautological sentence). The floor is by construction and structure pretty insensitive to market risk and offsetting recognition is rather poor.
The aspects I am surprised with are
1. How come the bank would have a CRM modelling? The JPMorgan is an US bank, and the US is only in a parallel run phase for B 2 and perhaps starting B 2.5 -so there would not have been a model validated for RWA purposes. The only assumption is had such a model validated by UK-FSA or else a pure standard approach for the CRM which is 100% (instead of the 8%)... .. or else it had just a Basel II internal model approach, which then would disqualify the discussion around Basel 2.5.
2. The CRM modelling indeed might enables to take advantage of hedging possibilities and indeed might be swift in doing that, but without knowing the modelling for sure it is difficult to infer solid argumentation. The CRM should encompass all price risk (on top of the positions being subject to general market risk charge)...
3. the "floor" is very sluggish, so I mean at the points in time where the positions were "accumulated greatly" there should have been a 12 weeks window at work. So even in Q2 2012 were the strategy changed, the increasing profile of the end of 2011 would act in the max. But then you "only" take 8% of the Standardized charge.
4.my reason for posting in the "hype trading section" while being the most ignorant in this area is because I still hold hopes i'll get a bit better at vaguely understanding this money making one day... I fear it is a bit hopeless.. anyway
Cheng you write
JPM set up a curve trade, long the long end, short the short end, probably using index CDS on CDX IG S9 (since the article mentioned tranches at one point it could also have been index tranches). I read elsewhere
"In the four months since the start of the year, the obscurely named CDX IG S9, an index of the credit default swaps written against the debt of many of the largest US companies, saw its notional size increase by 65pc to $148bn – an inflation largely put down to JP Morgan’s buying of credit protection." ok so this means they were concentrating on this index..
Question 1 : would you have an idea why- what could have been the strategy of that position? Hedging as they say in RM a portfolio of "US corporate positions" or?
The same telegraph source says..
"Taking such a large and illiquid position raised eyebrows, even earning one JP Morgan trader the sobriquet of the "London whale", and has now come back to haunt the bank as the value of the index has faltered, though not enough to account for the scale of the losses."
You say "when the curve steepens they get cooked"-
Could you detail what are the indicators and conditions that underly this. Another source presents this Soberlook or this one Zerohedge but that is the point I cannot make these curves talk to me-:-)
So how can the article argue around B 2.5
a) either the B 2.5 charge was not in place and in all cases the RM's punt on that is not justified.
b) a B 2.5 charge was in action- i.e. and perhaps a "Hypothetically exisiting JPMorgan CRM model" was so calibrated that under "fill-in market conditions bringing to higher volatility and change of curve steepness fo their positions"- the max charge should have been much much higher than the "floor", even with super swift offsetting, and this did not suffice to absorb losses... even if a RWA of 40bn is advertised in p.24.
I still do not get it... B 2.5 and RWA reduction would push you to hedge less, because off-setting in the floor is not very generous. So perhaps the main point is they were just under "B1 +" rules
Still fully puzzled Poly
My ??? in the reading was precisely the explaination of interaction with the "market strategy" and the RWA, I am not sure it works (at least for me). The RWAs in this area [if you count out the cap charges from usual VAR, and stressed Var-new with B2.5]..are the result of the maximum of two charges (A;B). The charge A: is determined by an internal modelling approach "usually labelled a CRM model". Basically A: is the max between a 12 weeks running window (t_12,..t_0) of "CRM" model charge and the charge for t_0.
The charge B "deemed a standardized floor" is obtained through taking 8% of a standardized capital charge which is obtained itself as a maximum of net longs and net shorts in the same window fashion as defined above. The capital charges in the standardized approach are to be applied to nontranched and tranched positions. For tranched positions: I believe that by utilisation of securitisation framework approaches- the SFA would be probably candidate/or concentration ratio approach (most probably the latter because US bank not fully B2)- because typically tranched Indices aren't rated. Of course the floor is not static, it fluctuates.
Concentration ratio works like that you look through the underlying pool and determine a standardized capital charge, then you compute a concentration factor i.e. total over sum of all tranches' width junior or pari passu to the one you are considering,- ie the junior CDX would have a cr=100/15=6.7 and the senior tranche attaching at 35 cr=1. Charge is then cr*charge of the pool. So a minimizing RWA strategy would have to try to use higher tranches more.
By construction it is quite clear that in some cases- tbd-, the RWAs are determined by the floor (=ceiling) and in other cases they would be defined by the "model" (sorry for this tautological sentence). The floor is by construction and structure pretty insensitive to market risk and offsetting recognition is rather poor.
The aspects I am surprised with are
1. How come the bank would have a CRM modelling? The JPMorgan is an US bank, and the US is only in a parallel run phase for B 2 and perhaps starting B 2.5 -so there would not have been a model validated for RWA purposes. The only assumption is had such a model validated by UK-FSA or else a pure standard approach for the CRM which is 100% (instead of the 8%)... .. or else it had just a Basel II internal model approach, which then would disqualify the discussion around Basel 2.5.
2. The CRM modelling indeed might enables to take advantage of hedging possibilities and indeed might be swift in doing that, but without knowing the modelling for sure it is difficult to infer solid argumentation. The CRM should encompass all price risk (on top of the positions being subject to general market risk charge)...
3. the "floor" is very sluggish, so I mean at the points in time where the positions were "accumulated greatly" there should have been a 12 weeks window at work. So even in Q2 2012 were the strategy changed, the increasing profile of the end of 2011 would act in the max. But then you "only" take 8% of the Standardized charge.
4.my reason for posting in the "hype trading section" while being the most ignorant in this area is because I still hold hopes i'll get a bit better at vaguely understanding this money making one day... I fear it is a bit hopeless.. anyway
Cheng you write
JPM set up a curve trade, long the long end, short the short end, probably using index CDS on CDX IG S9 (since the article mentioned tranches at one point it could also have been index tranches). I read elsewhere
"In the four months since the start of the year, the obscurely named CDX IG S9, an index of the credit default swaps written against the debt of many of the largest US companies, saw its notional size increase by 65pc to $148bn – an inflation largely put down to JP Morgan’s buying of credit protection." ok so this means they were concentrating on this index..
Question 1 : would you have an idea why- what could have been the strategy of that position? Hedging as they say in RM a portfolio of "US corporate positions" or?
The same telegraph source says..
"Taking such a large and illiquid position raised eyebrows, even earning one JP Morgan trader the sobriquet of the "London whale", and has now come back to haunt the bank as the value of the index has faltered, though not enough to account for the scale of the losses."
You say "when the curve steepens they get cooked"-
Could you detail what are the indicators and conditions that underly this. Another source presents this Soberlook or this one Zerohedge but that is the point I cannot make these curves talk to me-:-)
So how can the article argue around B 2.5
a) either the B 2.5 charge was not in place and in all cases the RM's punt on that is not justified.
b) a B 2.5 charge was in action- i.e. and perhaps a "Hypothetically exisiting JPMorgan CRM model" was so calibrated that under "fill-in market conditions bringing to higher volatility and change of curve steepness fo their positions"- the max charge should have been much much higher than the "floor", even with super swift offsetting, and this did not suffice to absorb losses... even if a RWA of 40bn is advertised in p.24.
I still do not get it... B 2.5 and RWA reduction would push you to hedge less, because off-setting in the floor is not very generous. So perhaps the main point is they were just under "B1 +" rules
Still fully puzzled Poly
И ветер, и дождик, и мгла Над холодной пустыней воды.
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Cheng
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- Joined: Thu Jan 01, 2004 12:00 am
Risk Magazine article: How B2.5 beached the London Whale
Mkay, lemme throw in my 2bps Smiley .
Question 1 : would you have an idea why- what could have been the strategy of that position? Hedging as they say in RM a portfolio of "US corporate positions" or?
Say you have a portfolio of US corporates that is "somehow" similar to the CDX IG S9 portfolio (for example same names or at least a reasonably high correlation). You are afraid of jump-to-default risk happening (think of Enron and WorldCom, IG corporates that go belly up over night). To hedge this risk you buy short dated credit protection on the index portfolio, for example 1 year or 3 years. If done in size this costs a boatload of money, loan margins are usually not sufficient to offset the cost of protection. So what should you do ? Easy, sell protection on the same index portfolio for longer maturities (7 or 10 years say). The rationale is that a default should happen within the near future or if it doesn't the companies live long and prosper. Which boils down to begin short the short end and long the long end.
You say "when the curve steepens they get cooked"-
Could you detail what are the indicators and conditions that underlie this.
Now assume you have an index position as outlined above. If short term spreads tighten you loose money (because you bought protection at higher spreads) and if long term spreads widen you loose money, too (because you sold protection at lower spreads, ie you were "too cheap"). Tighter short end and/or wider long end means the curve steepens. Which is pretty much what happened... Basically you are set up for nice profits if things behave well (since your short term protection matures at some point and you don't have to pay anymore) and a double whammy if things go wrong (because either move costs you money).
HTH.
Question 1 : would you have an idea why- what could have been the strategy of that position? Hedging as they say in RM a portfolio of "US corporate positions" or?
Say you have a portfolio of US corporates that is "somehow" similar to the CDX IG S9 portfolio (for example same names or at least a reasonably high correlation). You are afraid of jump-to-default risk happening (think of Enron and WorldCom, IG corporates that go belly up over night). To hedge this risk you buy short dated credit protection on the index portfolio, for example 1 year or 3 years. If done in size this costs a boatload of money, loan margins are usually not sufficient to offset the cost of protection. So what should you do ? Easy, sell protection on the same index portfolio for longer maturities (7 or 10 years say). The rationale is that a default should happen within the near future or if it doesn't the companies live long and prosper. Which boils down to begin short the short end and long the long end.
You say "when the curve steepens they get cooked"-
Could you detail what are the indicators and conditions that underlie this.
Now assume you have an index position as outlined above. If short term spreads tighten you loose money (because you bought protection at higher spreads) and if long term spreads widen you loose money, too (because you sold protection at lower spreads, ie you were "too cheap"). Tighter short end and/or wider long end means the curve steepens. Which is pretty much what happened... Basically you are set up for nice profits if things behave well (since your short term protection matures at some point and you don't have to pay anymore) and a double whammy if things go wrong (because either move costs you money).
HTH.
"No trade with death / No trade with arms / Dispense the war / Learn from the past"
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polysena
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- Joined: Thu Jan 01, 2004 12:00 am
Risk Magazine article: How B2.5 beached the London Whale
First thanks for the precise stating, even I have understood.
I believe the floor would not accommodate the hedging strategy you describe with a lot of off-sets because of diff maturities. My take is then article is not overly solid from the B2.5 etc argumentation. They JPMorgan might just not have had any model/floor based additional charges as in B2.5. Would you agree? thank you. Poly
I believe the floor would not accommodate the hedging strategy you describe with a lot of off-sets because of diff maturities. My take is then article is not overly solid from the B2.5 etc argumentation. They JPMorgan might just not have had any model/floor based additional charges as in B2.5. Would you agree? thank you. Poly
И ветер, и дождик, и мгла Над холодной пустыней воды.
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Cheng
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- Joined: Thu Jan 01, 2004 12:00 am
Risk Magazine article: How B2.5 beached the London Whale
In this case I revert to my earlier statement about RM and certain tabloids... only that RM doesn't show naked women.
"No trade with death / No trade with arms / Dispense the war / Learn from the past"
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polysena
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- Joined: Thu Jan 01, 2004 12:00 am
Risk Magazine article: How B2.5 beached the London Whale
"In the four months since the start of the year, the obscurely named CDX IG S9, an index of the credit default swaps written against the debt of many of the largest US companies, saw its notional size increase by 65pc to $148bn – an inflation largely put down to JP Morgan’s buying of credit protection."
and journalist make it sound really mysterious and absconding..
[edit: JP Morgan information talks about a "synthetic credit var model" there is no way to infer from that some B2.5 stuff.. what a Pinocchio article pffff but this is better Carol A. Actually there are some other articles of a better quality that help indicate the weakness of the RM article zeroalpha and zeroalphaonstrategy]
and journalist make it sound really mysterious and absconding..
[edit: JP Morgan information talks about a "synthetic credit var model" there is no way to infer from that some B2.5 stuff.. what a Pinocchio article pffff but this is better Carol A. Actually there are some other articles of a better quality that help indicate the weakness of the RM article zeroalpha and zeroalphaonstrategy]
И ветер, и дождик, и мгла Над холодной пустыней воды.