Market Risk Discussion

Posted: August 27th, 2021

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Market Risk Discussion

Question 1

According to the 10-K 2005, the framework for measuring price risk for trading portfolios included using complementary tools such as value-at-risk, stress testing, and factor sensitivities(Citigroup 10-K for 2005, 90). From the report, each trading portfolio is independently influenced by an individual market risk framework that encompasses the measures mentioned above, among other controls such as permitted product listing and approval processes for new and complex products. Specifically, during the period, Citigroup was involved continuously in performing extensive back-testing on several hypothetical test portfolios to ascertain accuracies in their value-at-risk. Back-testing involves counter-comparison of daily VAR of a test portfolio against ex-post changes in a portfolio’s market value(Citigroup 10-K for 2005, 90-91). As such, the framework performed back-testing to confirm the 99% confidence interval to ensure that the VAR calculation with different levels of risk concentration conforms to the set statistical criteria. However, the framework has remained the same according to the 10-K 2018 report. Citigroup 2018 report shows that the company still uses the same combination of qualitative and quantitative measures that include factor sensitivity, stress testing, and value-at-risk (VAR), thus retaining the same price risk measuring framework.

Question 2

Besides retaining a similar price risk measuring framework, the company added details in the 10-K 2018 report regarding the disclosure of risk management initially not included in the 10-K 2005(Citigroup 10-K for 2018, 102; Citigroup 10-K for 2005, 91). The first additional risk management aspect added is the use of covariance adjustments in the estimation of value-at-risks. Covariance adjustments are also referred to as the risk diversification benefits. According to the company, this factor is estimated as the difference between total VAR and aggregate VARs tied to each of the individual risk types(Citigroup 10-K for 2018, 101). Therefore, it is possible to understand the variations of changes across different risk types that the company is exposed to factors. It also discloses position changes and parameters of the models.

 Another critical component disclosed is the assumptions for hypothesized VAR. Unlike in the 2018 report, these assumptions were not adequately disclosed. Equally, the changes in the VAR model assumptions are independently validated by the organization. The validation process involves reviewing Citi’s Model Risk Management validation group(Citigroup 10-K for 2018, 103). Lastly, the 10-K 2018 report has also disclosed the total trading VAR that includes compiled mark-to-market and the certain fair value option trading positions. The components excluded from estimating total trading VAR, such as hedges to loan portfolios, all CVA exposures, and fair-value option loans, are specifically identified in the risk management framework. Hence, besides retaining the same risk management framework, the company has significantly changed in disclosure levels from 2005 to 2018.

Question 3

Unlike the 10-K report characterized by short discussions, Citigroup’s 10-K 2018 report’s lengthier discussion regarding risk management has improved my understanding of all the company approaches to risk management. Specifically, detailed discussions have made me understand the importance of disclosures in the financial statements. Companies need to explain to the public every aspect of their activities to limit doubts. Comprehensive disclosures are also necessary because they ensure compliance with standard regulations, thus pre-empting inquiries by the government and adequately respond to failures in the system. Equally, detailed disclosures in the current 2018 report imply that Citigroup was hiding information regarding its risk management framework. Hence, it was difficult for the company to combat fraud and mismanagement of shareholder’s equity and other illegal activities due to a lack of transparency in reporting.

Works Cited

Citigroup 10-K for 2018. Accessed 12^th November 2020 from https://www.citigroup.com/citi/investor/data/q1804c.pdf

Citigroup 10-K for 2005. Accessed 12^th November 2020 from http://www.citigroup.com/citi/investor/data/k05c.pdf