KIS 채권평가 - Beyond Pricing

KOR

Financial Solution

Consulting Service

EAD EAD Calculation MtF Calculation and Verification KIS-EAD
inform of Counterparty risk, Introduced EAD System, Future prospects
Counterparty risk
  • Significant uncertainty about economic loss due to default of counterparty
  • Exist in all transactions with counterparties on securities and derivatives
  • Diversification of financial products, increase in derivatives trading → Increasing demand for appropriate risk management
  • It occurs only when the contract with the counterparty has a positive (+) economic value at the time of default
  • Acceptance of offsetting and collateral maintenance agreements by credit risk mitigation method
Introduced EAD System
  • Most domestic EAD application methods use current exposure method
  • Expected exposure recommended, in Basel II
  • KIS EAD System calculates EAD by current exposition method, standard exposure method, expected exposure method, and build system based on expected exposition method
  • Verification of EAD results through back-testing
Future prospects
  • Basel II, III introduction of market standard pricing system
  • Demand for EAD evaluation system will increase due to strengthened regulation by FSS
  • Competitiveness in the market from experience of KIS EAD System
  • Back-Testing enforcement
  • Manpower secured to build risk management system in anticipation of demand increase

EAD calculation by Current Exposure Method (CEM)

EAD = (Replacement Cost) + (Additional items after offset)
  • Replacement Cost : Offset gains after offsetting the contracts with legally valid contract
  • Additional Items after offset: (Sum of additional Items Before Offset) X { 0.4 + 0.6 x (Replacement Cost) / (Total Replacement cost) }
  • Additional Development Item : (Notional Amount) x (Credit conversion rate)
  • Total Replacement Cost : Sum of individual Replacement Cost
Issues with Current Exposure Method
  • Focus on the P/L gains rather than the multiple transactions for offsetting contracts
  • Excessive or underestimation of regulatory capital → Possibility of arbitrage trading
  • Not able to fully reflect market conditions

EAD calculation using Standard Method

EAD = 1.4 × max{ ( Replacement cost ), ∑( Risk Position × Credit conversion rate) }
  • Replacement Cost : Offset gains after offsetting the contracts with legally valid contract
  • Risk Position : Hedging Group Risk Amount
  • Credit Conversion Rate: Hedging Group Credit Conversion Amount
Issues with Current Exposure
  • Risk Position within offset trades (eg, currency, remaining maturity, market factors)
  • Since the off-set can be sufficiently recognized within the hedging group, the net total amount of all the risk positions existing in the hedging group is used to calculate the EAD
Risk position
  • other than debt-equity instruments are underlying assets : (Risk position) = (effective nominal value) = (underlying asset price) × (delta)
  • debt-equity instruments are underlying assets: (Risk Position) = (effective nominal value) × (Modified duration)
  • Credit Default SWAP: (Risk Position) = (effective nominal value) × (reaming maturities )
Issues with Standard Method

Not able to fully reflect market conditions

Expected Exposure Method EAD Calculation

EAD = α + Effective EPE
  • Measure at the upper level
  • Specifies the expected distribution of changes in market value due to changes in market variables such as interest rate and exchange rate.
inform of Expected Exposure Method EAD Calculation - Probability model and parameter estimation, Create Scenario, MtF Calculation, Offsetting and Collateral Processing, EAD Calculation, EAD Distribution
Exposure
  • Expected exposure(EE) : The average value of the distribution of the exposures at each future point in the transaction before the maturity date of the transaction with the longest maturity
  • Expected positive exposure( EPE) : The time-weighted average of the expected exposures for a given period (the longest maturity or less than a year, which ever shorter )
  • Effective EE : Maximum expected exposures at or past period
  • inform of Effective EE
  • Effective EPE : The time-weighted average of the expected exposures for a given period (the longest maturity or less than a year, which ever shorter
  • inform of Effective EPE

Expected exposure

Exposure distribution and Effective EPE
inform of Exposure distribution and Effective EPE graph
Offset Method
inform of Offset Method

Comparison of CEM/SM and SA-CCR

inform of Comparison of CEM/SM and SA-CCR

MtF calculation method selection process (Closed MCS, FDM MCS, LS MCS)

inform of MtF calculation method selection process (Closed MCS, FDM MCS, LS MCS) - EAD SYSTEM, Price Formula, FDM
Closed-MCS Method, FDM-MCS Method, LS-MCS Method 계산과정 정보를 제공
Closed-MCS Method FDM-MCS Method LS-MCS Method
Applicable Conditions Price Formula Price Formula not available, but able to use FDM when two methods are not applicable
Calculation Process 01 Create Scenario
  • Apply the estimated parameter from the time series data to a given probability model
  • Consider correlations to risk factors
02 MtF Calculation
  • Calculate prices using formulas at each point in each scenario
  • Use implied volatility rather than historical volatility
03 Offset Processing 04 Effective Exposure Calculation

Replace negative numbers to zero after offsetting price

 01 Create Scenario 02 Price calculation using FDM
  • Calculate price by solving partial differential equations
  • If the risk factor is 1: Implicit
  • FDM, 2 cases: ADI or OSM
03 MtF calculation
  • The sum calculated by FFDM at each point in each scenario and calculate the price by linear interpolation method
  • Whether or not the barrier hits before each point in time, and then the initial cash flow are calculated from the scenario.
04 Calculate effective EE after offsetting 		01 Create Scenario 02 Price calculation for each scenario

Estimate future cash flow from each scenario and calculate price

03 MtF Calculation
  • At each given point in time, the prices are calibrated using the least squares method using the price of each scenario.
  • There is some difference in the distribution of results according to the objective function used in least squares
04 Calculate effective EE after offsetting

Back-Testing

Standard Back-Testing method
inform of Standard Back-Testing method
Counter party Back-Testing Method
inform of Counter party Back-Testing Method

History

inform of KIS-EAD History
  • Basel I(1988.07.) - To ensure the financial soundness of banks, introduced international standards for minimum capital adequacy ratio (BIS).
  • New BIS (Basel II)(2004.06.) - Increase the financial soundness of banks by strengthening the calculation method of capital ratio. (Counterparty credit risk management)
  • Counterparty Risk Research(2007.03.) - FSS requested Research on the counterparty risk measurement
  • KIS EAD System Develop(2007.12.) - Completed FSS Research request Completed KIS-EAD System
  • ㅇㅇBank KIS EAD integration(2009.12.) - ㅇㅇBank KIS-EAD System Intergration
  • Back-Testing(now,2012.01.) - EAD Progress Status Back-test R&D

Service Structure

System Structure
inform of Client System, KIS EAD System
System Description
inform of EAD system Output calculation process, Expected exposure method process
EAD system Output calculation process Expected exposure method process
  • 01 Enter transaction information and market information into the client system
  • 02 Transfer data from client DB to EAD DB
  • 03 Generate market information after data processing from EAD server
  • 04 EAD calculation (Current Exposure, Standard, Expected Exposure)
  • 05 Back-Testing
  • 06 Calculation result transfer to the client system
  • 01 Parameter estimation
  • 02 Create Scenario
  • 03 Calculation of future price distribution
  • 04 Offsetting process
  • 05 EAD calculation
Module Structure
inform of Module Structure
  • Parameter Estimation Module - HW Calibration, BK Estimation Module, Volatility Correlation coefficient Module
  • MtF Calculation Module - IRS, CRS, FX, FX Option, Equity Option
  • EAD Calculation Module - Current Exposure Method, Standard Method, Expected Exposure Method
  • Back-Testing Module - Exception calculation, CCDF calculation, test statistic calculation module

Screen and Function

inform of KIS-EAD Screen and Function
  • 01 Calculation date setting

    Enable MAR exchange when activating monthly operation

  • 02 Enter the counterparty code
  • 03 Parameter setting

    Enter the parameters that are the basis for scenario creation

  • 04 Settings for Back-Testing
  • 05 Back-Testing Detailed Result Value Setting
  • 06 Log Settings
  • 07 EAD generation input button
    • Data processing: Estimation and calculation of interest rates, equities, FX, correlation coefficients, etc.
    • Scenario Creation: Creating Interest Rates, equities, and FX Scenario
    • EAD output and DB storage
    • MTM calculation and DB storage
  • 08 Back-Testing Output button
  • 09 EAD Output Detail Log Screen
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