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Chapter
39 /
Financial Instruments: Disclosures,
(l FRS
7)
459
Value at risk ("VAR" )
(Audited)
One of the principal tools used by HSBC to monitor and limit market risk exposure is VAR. VAR
is a technique that estimates the potential losses that could occur on risk positio ns as a result of move–
ments in market rates and prices over a specified time horizon and to a given level of confidence.
The VAR models used by HSBC are predominantly based on historical simulation. The historical
simulation models derive plausible future scenarios from historical market rate time series, taking ac–
count of inter-relationships between different markets and rates, for example, between interest rates and
foreign exchange rates. The models also incorporate the impact of option features in the underlying ex–
posures.
The historical simulation models used by HSBC incorporate the followi ng features:
• Potential market movements are calcu lated with reference to data from the last two years;
• Historical market rates and prices are calculated with reference to foreign exch ange rates and
commodity prices, intere st rates, equity prices and associated volatilities:
• VAR is calculated to a 99% confidence level; and
• VAR is calculated for a l-day holding period.
HSBC routinely validates the accuracy of its VAR models by back testing the actual daily profit and
loss results, adjusted to remove nonmodeled items such as fees and commis sions, against the corre–
sponding VAR numbers. Statistically, HSBC would expect to see losses in excess of VAR only 1
%
of
the time over a I-year period. The actual number of excesse s ove r this period can therefore be used to
gauge how well the models are performing.
Although a valuable guide to risk, VAR should always be viewed in the context of its limitations.
For examp le
• The use of historical data as a proxy for estimating future even ts may not encompass all potent ial
events, particularly those which are extreme in nature;
• The use of a l-day holding period assumes that all positions can be liquidated or hedged in one
day. This may not fully retlect the market risk arising at times of severe illiquidit y, when a I-day
holding period may be insufficient to liquidate or hedge all positions fully;
• The use of a 99% confidence level, by definition, does not take into account losses that might oc–
cur beyond this level of confidence; and
• VAR is calculated on the basis of exposures outstanding at the close of business and therefore
does not necessarily retlect intraday exposures.
HSBC recognises these limitations by augmenting its VAR limits with other position and sensitivity
limit structures. Additionally, HSBC app lies a wide range of stress testing, both on individu al portfo lios
and on the Group' s consolidated positions. HSBC' s stress-testing regime provides senior manageme nt
with an assessme nt of the financial impact of identified extreme event s on the marke t risk expos ures of
HSBC.
The VAR, for both trading and nontrading portfolios, for Global Markets was as follows:
Value at risk
(Audited)
At 3 1 December
Average
Minimum
Maximum
2006
US$m
67.3
74.3
39.4
137.5
2005
US$ m
128.5
174. 1
108.2
248.8
Maximum
Total VAR at 3 1 December 2006 fell compared with 3 1 December 2005. The major cause of this
was a reduction in risk positions arising from the Group' s balance sheet management activities.