A Review of the Fundamentals of the Fundamental Review of the Trading Book II: Asymmetries, Anomalies, and Simple Remedies

30 Pages Posted: 31 Aug 2018

See all articles by Hany Farag

Hany Farag

CIBC World Markets - Risk Quant, Capital Markets, CIBC

Multiple version iconThere are 2 versions of this paper

Date Written: August 15, 2018

Abstract

In this paper, we highlight some anomalies in both the standardized approach (SA) and the internal models approach (IMA) of the Fundamental Review of the Trading Book (FRTB) that may not be well known. These anomalies may be unintentional and simply require clarification or rewording of the FRTB text. Alternatively, they may be aspects that were not fully considered from certain angles. Here, we wish to highlight the unintended consequences of ignoring them. These anomalies vary in the degree to which they impact capital, and they can grossly misstate risk in either direction. Indeed, we demonstrate in many cases that the framework can record high risk when there is none, or record zero risk when the risk is high. We offer simple adjustments to eliminate these problems. None of our suggestions require new calibration or a material change to the framework; they are just minor modifications to the wording of the text that can restore logical consistency. It is our hope that this paper will assist both regulators and practitioners in a productive dialog.

Keywords: Fundamental Review of the Trading Book (FRTB), standardized approach (SA), internal models approach (IMA), market risk, Basel III reforms

Suggested Citation

Farag, Hany, A Review of the Fundamentals of the Fundamental Review of the Trading Book II: Asymmetries, Anomalies, and Simple Remedies (August 15, 2018). Journal of Risk, Vol. 20, No. 6, 2018, Available at SSRN: https://ssrn.com/abstract=3240560

Hany Farag (Contact Author)

CIBC World Markets - Risk Quant, Capital Markets, CIBC ( email )

161 Bay Street
Toronto, Ontario M5J 2S8
Canada

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