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Estimating Bank Trading Risk: A Factor Model Approach

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Author Info
James O'Brien
Jeremy Berkowitz
Abstract

Risk 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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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11608.

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Date of creation: Sep 2005
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Handle: RePEc:nbr:nberwo:11608

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G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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References listed on IDEAS
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  1. Stephen J. Brown & William N. Goetzmann, 2001. "Hedge Funds With Style," NBER Working Papers 8173, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Fung, William & Hsieh, David A, 1997. "Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(2), pages 275-302.
  3. Mark Mitchell, 2001. "Characteristics of Risk and Return in Risk Arbitrage," Journal of Finance, American Finance Association, vol. 56(6), pages 2135-2175, December. [Downloadable!] (restricted)
  4. Jeremy Berkowitz & James O'Brien, 2002. "How Accurate Are Value-at-Risk Models at Commercial Banks?," Journal of Finance, American Finance Association, vol. 57(3), pages 1093-1111, 06. [Downloadable!] (restricted)
  5. Leippold, Markus & Trojani, Fabio & Vanini, Paolo, 2006. "Equilibrium impact of value-at-risk regulation," Journal of Economic Dynamics and Control, Elsevier, vol. 30(8), pages 1277-1313, August. [Downloadable!] (restricted)
  6. Tobias Adrian & Michael J. Fleming, 2005. "What financing data reveal about dealer leverage," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Mar. [Downloadable!]
  7. Morris, Stephen & Shin, Hyun Song, 1999. "Risk Management with Interdependent Choice," Oxford Review of Economic Policy, Oxford University Press, vol. 15(3), pages 52-62, Autumn.
  8. Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(1), pages 63-98. [Downloadable!] (restricted)
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