t r
, ,
) ( q o + =
I D D
t t t
~ ~ ~
2 1
c q
) ( ) (
) ), ( ( ) (
,
,
t x
P
S
D t y
t x f t y
l
e
l
e l
l e e l
=
= u
t t
t m
t
t
q
q
q A =
(
(
(
=
,
, 1
=
+ + =
m
i
k i ki k
t t r t x
1
) ( ) ( ) ( c  o
6
6
Risk Modeling Methodologies
Delta Normal
Approximation
Pure Historical
Simulation
Filtered Historical
Simulation
MonteCarlo
Normal Simulation
Modeling assumptions
Simplified but high
performance approach
Accounting for covariance
dynamics
Improved forward looking
Handling of instrument with
Insufficient historical data
Linearization
Normality assumption
Crossproduct dependency
by Covariance
Risk factor compression
No distribution assumption
Easy to understand / often
used
Exact treatment of
derivatives
Modeling assumptions
Modeling assumptions
Modeling assumptions
Future = past
Constant volatility
Constant correlations
Risk factor compression
Dynamic correlation/vola
Non parametric
assumption of residuals
Risk factor compression
Normality assumption
Crossproduct dependency
by VCV
No inclusion of fattail
Risk factor compression
Accounting for covariance
dynamics
Inclusion of fattails
Improved forward looking
Exact treatment of
derivatives
Handling of instrument with
Insufficient historical data
Accounting for covariance
dynamics
Improved forward looking
Exact treatment of
derivatives
Features Features Features Features
1
3
Ensured by:
Volatility filter &
Quantile
correction
1
Ensured by:
Inclusion of
specific risk
2
3
Largescale
Mediumterm
Mediumscale
Shortterm
Ensured by:
Analytical
mapping of
instruments
3
2
1
2
2
Improvements
+ 
.

\

= = =
T
t
m
i
ki i
m
i
i ki k
T t r t x
ki
1 1
2
1 ,
) ( ) (
min
 e 
 o
see Tibshirani, R. J. (1996)
,1
,2
,3
2
( )
2
1
0
,
2
,
1
0
,
) (
1
1
, ) (
1
1
=
J
j
j t i i
j
J
t i
J
j
i
j
J
t i
j t r
j t r
t i t i i
t r
, ,
) ( q o + =
.
) ) 1 ( (
,
,
1 ,
t i
t i i
t i
t r
o
q
+
=
+
t i T i T i
t r
, , ,
) (
~
q o =
1
see BaroneAdesi et al.(1998)
1
1
see Franconi and Herzog (2012)
1
0 500 1000 1500 2000 2500
0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
Time points
F
r
e
q
u
e
n
c
y
o
f
V
i
o
l
a
t
i
o
n
s
0 500 1000 1500 2000 2500
0.01
0
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
Time points
F
r
e
q
u
e
n
c
y
o
f
V
i
o
l
a
t
i
o
n
s
1
Portfolio Aggregation using the Delta Normal Approximation
Risk Factor Data
i t
r
,
r : Return
t : Time
(
(
(
=
m t
t
t
r
r
r
,
1 ,
...
) (
t
r mean =
Client Position
Weights
Instrument Data
Derivatives and
Structured Products
, z k
v
,k t
x
,k e
o
Betas on Risk
Factors 
k,i
, c
k
v : Weights
z : Client portfolio id
x : Instrument returns
k : Instrument no.
o : Delta (first order derivative)
e : Derivative no.
c
k
: Idiosyncratic risk (specific risk)
E
c
: Intrinsic covariance matrix
 : Beta value of kth instrument
to ith benchmark/risk factor
E: covariance matrix risk factors

k,i
= OLS(x
t,k
, r
t,i
, selection rules)
 = [ 
k,i
] matrix nxm
( )
n
diag c c
c
...
1
= E
Risk
LT
E
, z k
v
i k,

c
E
z corrected
T T T
z
VaR
Dv D v v D D v
o o
  o
c
) (
1
u =
E + E =
(
(
(
(
=
k e
k
D
,
, 1
. 0 0
. ... . 0
0 . ... .
0 0 .
o
o
D
3
3
Portfolio Aggregation using scenarios
Risk Factor Data
i t
r
,
r : Return
t : Time
(
(
(
=
m t
t
t
r
r
r
,
1 ,
...
) (
t
r mean =
Client Position
Weights
Instrument Data
Derivatives and
Structured Products
, z k
v
,k t
x
,k e
f
Betas on Risk
Factors 
k,i
, c
k
v : Weights
z : Client portfolio id
x : Instrument returns
k : Instrument no.
f : derivative fomula
e : Derivative no.
c
k
: Idiosyncratic risk (specific risk)
: scenarios of the risk factors
 : Beta value of kth instrument
to ith benchmark/risk factor
: scenarios of the idiosyncratic risk

k,i
= OLS(x
t,k
, r
t,i
, selection rules)
 = [ 
k,i
] matrix nxm
Risk
) (
~
,
s r
T k
, z k
v
i k,

c
~
)) (
~
( ) ) (
~
(
) (
~
) (
~
) (
~
) (
~
) (
~
2
1
2
1
1 1 1
s r quantile VaR s r
s s r f v s s r v s r
port Z port
S
s
z
l i
m
i
li e
E
e
e
K
k
k i
m
i
ki k port
corrected
o
o
c  c 
= =

.

\

+
+ 
.

\

+ =
=
=
= = =
e
f
3
3
) (
~
,
s r
T k
) (
~
s
k
c
0.6
0.4
0.2
0
0.2
0.4
0.6 0.4 0.2 0 0.2
A
n
a
l
y
t
i
c
a
l
B
e
t
a
s
(
P
C
1
)
Regressed Betas (PC1)
0.4
0.2
0
0.2
0.4 0.2 0 0.2 0.4
A
n
a
l
y
t
i
c
a
l
B
e
t
a
s
(
P
C
2
)
Regressed Betas (PC2)
1
0.5
0
0.5
1
0.6 0.4 0.2 0 0.2 0.4
A
n
a
l
y
t
i
c
a
l
B
e
t
a
s
(
P
C
3
)
Regressed Betas (PC3)
2
1
) ( ) ( ) ( t t t r
j j
c o + =
2
3
In order to improve the forwardlooking properties of the
model
A volatility filtering procedure is applied
A weighing factor is used in the computation of historical
volatilities (EWMA) or a GARCH type model
23
96 . 0 =
95 . 0 =
94 . 0 =
9 . 0 =
99.5% 99% 95% 90%
99.87% 99.62% 96.55% 91.86%
99.78% 99.43% 96.02% 91.24%
99.73% 99.35% 95.81% 90.93%
99.68% 99.27% 95.61% 90.74%
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