Financial Risk Manager Part 1
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After consistently breaching risk limits, CIO traders at JPMorgan Chase & Co. proposed a total overhaul of the VaR model in use at the time, claiming that the model was too conservative. A new VaR model was eventually developed. Which of the following statements is most likely correct?
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A
The new model was developed and by CIO traders in collaboration with the office of the Comptroller of Currency.
B
The new model resulted in risk numbers that were 50% higher than prior numbers.
C
The new model successfully corrected the mathematical flaws present in the first model, which had produced highly overstated risk estimates.
D
The new model was eventually revoked and the prior one reinstated.
Explanation:
The new VaR model developed by the CIO traders at JPMorgan Chase & Co. was eventually revoked and the prior one reinstated. This decision was made after the bank's Model Risk and Development Office identified several mathematical and operational flaws in the new model. These flaws included:
- Coding errors in the calculation of hazard rates and correlation estimates
- Use of unrealistically low volatility for illiquid securities
- Use of a Uniform Rate option instead of the Gaussian Copula model required under Basel 2.5
The new model had resulted in risk numbers that were 50% lower than the previous numbers, which encouraged more speculative trading and high-risk strategies. The revocation of the new model and reinstatement of the old one was a significant step taken by the bank to address these issues and mitigate the risks associated with the flawed model.
Why other options are incorrect:
- A: The new model was not developed in collaboration with the Comptroller of Currency - it was developed internally within JPMorgan
- B: The new model actually resulted in risk numbers that were 50% LOWER, not higher
- C: The new model did not correct mathematical flaws but instead introduced new flaws that understated risks
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