The Areas of Market Risk: Control, Reporting, Modelling
Having worked for a number of years in market and counterparty credit risk (under market risk) in the sell-side i.e. banks, I like to view and categorise the market risk function into 3 distinct but related areas.
In today’s post, I’ll give you a broad sense of these three areas of market risk in terms of what they are and what key skills and qualifications are generally required. By the end of this post, hopefully you’ll get a feel of where you’d like to be.
Here are the 3 areas: Risk Control, Risk Reporting, Risk Modelling.
Market Risk Area #1: Risk Control
What is it?
Risk control is about keeping things in check and maintaining order.
For example, police officers maintain social order by ensuring people abide by the law. Similarly in market risk, this means the firm deals within specific limits and only takes risk within its appetite. Enforcing this is the job of controllers so think of them as police officers of the firm.
Risk controllers also ensure that for all products that the bank trades, the risk capture is sufficient. That is, the bank at least captures and manages key risks.
What skills do I need?
First, risk controllers should have a good sense of the financial markets. One way to define “good sense” is the understanding of what drives financial markets and asset prices. This enables them to anticipate where the market risks are with respect to the firm’s portfolio and take preemptive action to mitigate these risks.
Second, risk controllers should have a strong foundation in product pricing and valuation. This includes understanding how a product’s market value changes with change in corresponding risk factors. This enables them to identify the risk factors of a product and link them with relevant market moves. More importantly, it allows them to distinguish key risk factors versus less important ones.
Third, risk controllers require solid communication skills. A large part of a controller’s job is to approve new trades and investigate limit breaches. This means they need to talk to the business often to understand their trading strategy and rationale behind certain actions. Having good communication skills allows controllers to collaborate better with traders, understand issues, and move swiftly to resolve them.
Market Risk Area #2: Risk Reporting
What is it?
Risk reporting centers around the correct and timely delivery of risk data, which is crucial to facilitate analysis and reporting. Risk data here refers to the common risk measures used in market risk management.
For instance, VaR and ES are market risk commonplace measures in the industry today that often show up in internal and external reports. Sensitivities or Greeks reports are another set of universal and critical risk measures for daily risk management.
Once generated, these reports are potentially sent to multiple stakeholders. For example, traders receive these reports to understand their risk exposure vs limits and risk controllers for analysis. Financial reporting and regulatory submissions also require the provision of risk data and thus, often involve the risk reporting team as well.
If risk controllers are police officers, risk reporters are equipment specialists -they provide the weapons and equipment necessary for the officers to do their job.
What skills do I need?
First, risk reporters need to be comfortable and skilled in managing large amounts of data. In a typical bank setup, there are multiple trading desks that each look after a combination of an asset class and instrument e.g. interest rate derivatives desk. At minimum, risk reporters would send daily risk sensitivity reports and VaR and / or ES reports for each desk for risk management purposes. Being comfortable and skilled in data enables reporters to create these reports quickly and send them out.
Second, risk reporters need to be detailed oriented. Risk reports appear throughout the firm in essential areas such as day-to-day risk management, management reporting, financial reporting, and regulatory submissions. Therefore, integrity of these numbers is critical and data issues should be fixed as soon as possible. An eye for detail lets reporters spot inconsistencies and mistakes in reports and rectify them before it gets spotted by someone else.
Third, risk reporters should have strong knowledge on systems and architecture and databases. Being familiar with the firm’s internal pricing and risk systems allows them to extract required risk data quickly. Knowing where data is stored and how they are piped across systems further empowers risk reporters to quickly assemble necessary risk data together.
Market Risk Area #3: Risk Modelling
What is it?
Risk modelling revolves around the implementation, validation, and maintenance of models and methodologies used in the firm.
The key role of risk modellers is to measure risk using systematic reasoning and scientific tools available in the quantitative fields of mathematics, statistics, computer science and so on. As such, the financial industry often refer to this group of people collectively as “Quants”, a shorthand for “quantitative analyst”.
If controllers are police officers and reporters are equipment specialists, risk modelers would be defense scientists – the people who design and test these equipment, ensuring they are fit-for-use.
What skills do I need?
First, risk modellers should be technically strong in quantitative areas. Mathematical finance, probability and statistics, computer and data science are a few key areas relevant to market risk. This as risk quantification heavily relies on tools in these areas. Hard technical skills enable modelers to understand the theory and models, laying the foundation for actual implementation of these models.
Second, modelers have to possess strong coding skills. Similar to the above, coding is a hard skill that is crucial in today’s world. Solid coding skills enable modelers to quickly prototype models and test them out. More importantly, many market risk models require coding in languages such as Python, C#, C++ in actual implementation. Thus, solid coding skills allows modelers to do their job faster and more effectively.
Third, modelers need to have strong logical thinking and communication skills to break down and explain complex topics in a simple way. Modelers often receive questions on model behavior and these usually come from business stakeholders such as traders or business managers. Since stakeholders are less involved in the details of modeling and are just consumers of the outputs, they rely on modelers to help them understand the same better.
Finding out your interest
The above is not to say the the market risk field only comprises these three areas. Indeed, actual functionalities depend on the specific role and would differ across financial institutions.
Most likely, the role would lie at the intersection of one or more areas – the below JD was listed on Google in beginning Jun 2020 and is a good example of a role that intersects modeling and risk control.
Now, in which area of market risk does your interest lie?
Leave your comments in the section below and lets discuss!
Risk Manager by Profession, Mentor and Coach by Passion.
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