Bank's Trading Book and Value-at-Risk

Abstract

The study identified and measures the market risk faced by the banks in trading book which includes positions taken with a short term horizon and for speculative purposes. The financial instruments that are good proxies for the market risk factors in trading book such as interest rates risk, stock prices risk, exchange rate risk and commodity price risk are identified and mapped respectively. The secondary market data for the study collected for the financial instruments in the bank’s trading book which covers the above mentioned risk factors. The financial instrument analysed using the market data available for the respective market risk factors. The market risk measured for each financial instrument and for the overall portfolio using Value-at-Risk. The Value-at-Risk is calculated at 95% and 99% confidence level and horizon for one day and ten days for each financial instrument and the trading book under study. The weights for individual risk factor in the trading book are in proportion to the position/exposure in the trading book. The Value-at-Risk evaluated using backtesting for financial instrument and the trading book. The Value-at-Risk calculated using Monte-Carlo Simulation method shows better result to capture market risk when a portfolio/book contains position in instruments with a non-linear payoff.

Keywords: trading book, market risk, Value-at-Risk, variance-covariance, Monte-Carlo simulation, backtesting