Estimating Bank Trading Risk: A Factor Model Approach
AbstractRisk in bank trading portfolios and its management are potentially important to the banks%u2019 soundness and to the functioning of securities and derivatives markets. In this paper, proprietary daily trading revenues of 6 large dealer banks are used to study the bank dealers%u2019 market risks using a market factor model approach. Dealers%u2019 exposures to exchange rate, interest rate, equity, and credit market factors are estimated. A factor model framework for variable exposures is presented and two modeling approaches are used: a random coefficient model and rolling factor regressions. The results indicate small average market exposures with significant but relatively moderate variation in exposures over time. Except for interest rates, there is heterogeneity in market exposures across the dealers. For interest rates, the dealers have small average long exposures and exposures vary inversely with the level of rates. Implications for aggregate bank dealer risk and market stability issues are discussed.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11608.
Date of creation: Sep 2005
Date of revision:
Publication status: published as James M. O'Brien, Jeremy Berkowitz. "Estimating Bank Trading Risk. A Factor Model Approach," in Mark Carey and René M. Stulz, editors, "The Risks of Financial Institutions" University of Chicago Press (2006)
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Find related papers by JEL classification:
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-09-29 (All new papers)
- NEP-FIN-2005-09-29 (Finance)
- NEP-FMK-2005-09-29 (Financial Markets)
- NEP-RMG-2005-09-29 (Risk Management)
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