Value at Risk Aggregation – A Major Challenge of Risk Management

One of the major challenges in the management and measurement of risk that many financial institutions face is finding a coherent approach to value at risk aggregation. Some of the drivers behind this challenge are developments in regulatory standards and requirements (Basel II and Basel III regulations) and the financial tumult in the recent years.

There are different types of risk that have distinct distributional properties, affecting the complexity of risk aggregation. The different types of risks financial institutions consider include:

  • Market risk (VaR)
  • Credit risk (CVA)
  • Operational risk
  • Liquidity risk (LCR)
  • Systemic risk
  • Pension risk
  • Concentration risk
  • Strategic risk
  • Reputational risk
  • Legal risk

Value at risk aggregation relates to the incorporation of market risk to estimate the amount of capital necessary to absorb potential losses associated with VaR measures.

To handle the VaR aggregation challenge, solutions are developed to handle VaR measures using common definitions of risk and economic capital methodologies that aggregate multiple market risks into a single metric.

According to a survey done by Basel Committee on Banking Supervision There are two basic approaches for creating a single metric for all VaR measures. One approach is aggregating across entities by VaR measures and subsequently aggregating these measures into groups. Another approach is to first aggregate VaR measures by entity and subsequently across entities. Consistency and accuracy of data was cited as crucial in determining how aggregation is performed.

Systems used by financial entities for value at risk aggregation must be able to collect and analyze data constantly and accurately in addition to having the ability to aggregate and analyze huge volumes of data for assessing VaR measures. This allows producing reports that are usually produced on a quarterly or annual basis on a daily basis, to accurately provide current VaR data.

Our ActivePivot system is a real time OLAP solution with advanced value at risk aggregation capabilities. The system can instantly aggregate non-linear data from multiple sources, including capital markets activities, retail banks, financial projects, and in high volumes and analyzes new vectors to produce new VaR measure across all views.

Additionally, ActivePivot allows users to run complex sets of simulations on a single trade or a group of trades, including historical and stress simulations. The solution can also be customized with sets of limits at different levels of hierarchy, and aggregated risks that breach the set limits are reported directly to the analysis dimension. All these capabilities allow users to perform quick ‘slice and dice’ and drill-through to reach underlying data or build up to provide a top-level overview, and enable better informed decisions.

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