Overview
Risk exposure is a focal point of vital importance for all international markets and clearing organizations. As world financial derivatives markets expand and counterparty credit risk increases in size and complexity, an organization's ability to assess its exposure to credit risk has become even more critical. The Options Clearing Corporation's System for Theoretical Analysis and Numerical Simulations provides this capability.
The Options Clearing Corporation is the first derivatives clearinghouse in the world to use a large-scale Monte Carlo-based risk management methodology. This methodology - called "STANS," for System for Theoretical Analysis and Numerical Simulations - is used to measure the exposure of portfolios of options, futures and cash instruments cleared and carried by OCC on behalf of its Clearing Members. STANS allows clearing institutions to measure, monitor and manage the level of risk exposure of their members' portfolios.
Methodology
Net Asset Value Component
The mark to market component takes the form of Net Asset Value (NAV) calculation that provides debits or requirements for net short positions and credits for net long positions. The debits and credits are netted to determine the NAV of every portfolio. The NAV component represents the cost to liquidate the portfolio at current prices by selling the net long positions and buying back the net short positions.
Risk Component
The additional risk component, the portion of the total requirement that covers market risk, is estimated by means of dynamic Expected Shortfall risk measures obtained from large-scale Monte Carlo implementation of copula-based approach with heavy-tailed marginal distributions. STANS generates a set of 10,000 hypothetical market scenarios intended to provide a realistic statistically consistent evaluation of risk at portfolio level. These simulated scenarios incorporate information extracted from the historical behavior of each individual security (risk group) as well as its relationship to the behavior of other securities (risk groups). Scenarios are generated for over 7,000 risk groups, including a broad range of individual equities, exchange traded funds, stock indices, currencies and commodity products.
In order to measure increased portfolio risk given atypical market conditions, STANS generates complementary sets of 10,000 scenarios intended to stress the distributions of the individual risk factors as well as their joint distributions.
At every scenario all financial instruments are re-priced using advanced models and hypothetical portfolio Profit/Loss (P/L) is estimated. Iteration over all scenarios leads to the portfolio P/L distribution, which is used to extract common risk measures such as Expected Shortfall (ES). Complementary risk measure as Component ES and Incremental ES are estimated to account for risk-factor specific risk.
The combination of the NAV component and the Risk component constitutes the total requirement for a given portfolio.
The more accurate portfolio risk estimations in STANS should improve the financial stability of the derivatives markets, and produce clearing and settlement efficiencies beneficial to investors.