Join PRMIA for an evening of Thought Leadership!

Model Limitations and the Credibility of the Risk Management Function in Valuing Illiquid Securities

June 10

Fields Institute

Dan Rosen

Re-Thinking Valuations: The Financial Crisis, Illiquid Markets and the Limits of our Models 

Regulators and industry associations have highlighted the need for transparency and better governance around valuations, as well as the inadequacy of many standard valuation and risk modelling approaches used by industry participants. For example, valuations have often relied too heavily on external credit ratings and dealer quotes. When dealing with complex structures and markets with limited liquidity, it is important to understand the meaning and use of a “price”. In this session, Dan will discuss current challenges on valuations, as well as some evolving best-practices we are re-learning as the global banking system is coping with the legacy of the crisis. We draw some examples, from the marking of seemingly “simple” books of credit instruments, to more complex structured finance and the inclusion of counterparty credit risk (CVA). As an industry, we must acknowledge the sometimes “heroic” assumptions in our models and the limitation of the information which we can reasonably extract from the market. In addition, it is vital to effectively incorporate expert judgement and develop explicit model risk and stress testing approaches which can help us better understand the behaviour of instruments and portfolios, together with their risks and “Knightean” uncertainties we could be facing. 

Marcus Cree

The Central Role of the Risk Management Function and its Credibility

Organizations that invest in developing their risk infrastructure will be positioned to navigate the internal and external pressures being placed upon risk management, including credible pricing capabilities. But is that enough to achieve a successful risk culture? Within this session, Marcus will cover the core elements required for a risk framework that encompasses both production and distribution and enriches the credibility of the risk management function – especially in light of the issues raised by Dan Rosen earlier in the session. How does the risk management function become the center of excellence in valuations and risk methodologies and calculations? How can the risk management function become the communication hub between complex risk taking and senior management risk strategy? Can the right infrastructural design empower the risk management function and allow a truly credible culture of risk to flourish? These are some of the questions Marcus will explore. 



 

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