Adaptive Stress PRMIA Webinar Final

8/10/2019 Adaptive Stress PRMIA Webinar Final

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‹#›

daptive Stress Testing

with FN HeavyTails

Alan Laubsch

Athos Risk,

Financial Network Analytics

&

Winhall Consulting LLC



ADAPTIVE STRESS TESTING WITH FNA HEAVY TAILS

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PRMIA Webinar

Oct 29, 2014

Alan Laubsch

Director, VP of Risk Products

A new way to see risk with network science



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Agenda

1. Adaptive Stress Testing Framework

2. Financial Cartography using Network Science

3. HeavyTails Systemic Risk Monitor



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Implication of Complexity

From “Predict & Control” to “Sense and Respond”

with Dynamic Steering



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Seek to understand hidden fault lines…While Qantas & CX rerouted, many continued business as usual:

“We've flown this route for many years, it's safe and that's the reason

why we are taking this route”

Source: BBC



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Adaptive Stress Testing: An ecosystem

powered by Macro and Micro intelligenceI. Macro: identify potential risks (hidden, structural)

•Stress Library based on Thought Leaders

•Focus on cycles (e.g., credit bubbles), amplifiers, imbalances, critical points

•E.g., Robert Shiller: (a) tech bubble (2000), (b) housing bubble (2005)

II. Micro: monitor visible risk with market signals

•Construct Stress Indices using traded factors to represent scenarios

•Monitor market signals, focusing on outliers and critical points•Examples: vol spike in (a) tech stocks and (b) US mortgages & financials

See: Adaptive Stress Testing: Amplifying Network Intelligence by Integrating Outlier Information

(Laubsch 2014)



A Social Markets Hypothesis

Source: Wikipedia; see Geoffrey Moore’s “Crossing the Chasm” (1999)

1.Macro: Scenarios from Innovators

2. Micro: Market signals from Early Adopters



U.S. Subprime Bond Early Warning Case Study

S p r e a d

C h a n g e

-90.0%

-60.0%

-30.0%

0.0%

30.0%

60.0%

90.0%

120.0%

Date

7/19/06 9/5/06 10/23/06 12/8/06 1/29/07 3/16/07 5/2/07 6/19/07 8/6/07 9/21/07 11/8/07 12/28/07 2/15/08 4/4/08 5/21/08

300%+ increase in vol

from Dec 12 to 21 '06

99% VaR bands vs 2006-1 AAA spread changes

HSBC subprime disclosure triggers a 12 sd move on Feb 23

Ratings agencies initiate reviews and/ordowngrades week of July 9 '07

Source: Alan Laubsch “Subprime Risk Management Lessons”, RiskMetrics

2. GS exits

subprime

(Micro)

1. Robert Shiller warns of housing Bubble in 2005 (Macro)



Three Stages of Risk: U.S. Subprime Crisis

0

125

250

375

500

1/19/06 4/19/06 7/19/0610/18/061/19/07 4/19/07 7/19/0710/18/071/22/08 4/22/08

Dec ’06: first tremor

Feb 23 ’07: HSBCsubprime loss disclosed

AAA Sub rime Bond S reads 2006-1

First ratings agency

downgrades week of

July 9 '07

bp's

1. Hidden Risk

Innovators

2. And the biggest surprise?1. When was the biggest risk?

2. Emerging

Early Adopters

3. Crisis

Early Majority



Survey Question

How does your organization use outlier based risk signals?

1) We don’t monitor outliers

2) We highlight outliers in risk reports

3) We organize meetings to discuss significant outliers



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Network Theory: uncover hiddenpatterns in complex data

Structure of links

between nodes matters

Augments, does notreplace other data

analysis methods

Network aspect is an

unexplored dimension of

ANY data



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A map is a set of points, lines, and areas definedby a coordinate system

Eratosthenes' map of the known world c. 194 BC



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Maps reduce multidimensional data intoa two dimensional space



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We can zoom in to details at different

levels…



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…and depict key systemic features



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Market linkages Clustering

Bilateral exposure data Asset price data Balance sheet data

Financial Cartography revealsinterconnectedness

Central nodes


http://slidepdf.com/reader/full/adaptive-stress-prmia-webinar-final 20/64‹#› www.fna.fi Alan Laubsch [email protected] ‹#›

World's Ocean Currents

NASA Scientific Visualization Studio

http://www.flickr.com/photos/gsfc/7009056027/



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Survey Question

Where might your organization benefit from applying networktheory? [select any that apply]

1) Systemic risk monitoring

2) Counterpart credit monitoring

3) Monitoring traders / portfolio managers

4) Viewing internal data

5) Other



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Agenda

1. Adaptive Stress Testing Framework

2. Financial Cartography using Network Science

3. HeavyTails Systemic Risk Monitor



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Time series of asset returns

Example: Daily returns of asset

prices (e.g., ETFs)

Difficult to understand large-scale

correlation or other dependencestructures of financial assets.

How to put the correlations and

their changes in context with

changes/returns and volatility?

Objective is to efficiently

represent a complex system

moving in time

!



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Correlation Networks

We encode correlations aslinks between the correlatednodes/assets.

Red link = negative correlation

Black link = positive correlation

Absence of link marks thatasset is not significantlycorrelated.



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Dimensionality Reduction & Filtering

Next, we identify the MinimumSpanning Tree (MST) and filterout other correlations.

Rosario Mantegna (1999)

‘Hierarchical Structure inFinancial Markets’

This shows us the backbonecorrelation structure whereeach asset is connected withthe asset with which itscorrelation is strongest.



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“Here be Dragons”

Didier Sornette (2009)

Dragon King: “Extreme events can bepredicted”

Benoit B. Mandelbrot (1963)

Volatility Clustering: “Large changes

tend to be followed by large changes”

-> Identify VaR exceptions (returnoutside 95% VaR bounds)

-> Map them as bright green or rednodes

Track the number of outliers

each day

Highlight outliers in their context



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HeavyTails Systemic Risk Analytics

See http://bit.ly/1j24pIH

http://bit.ly/1j24pIH



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Case: Escalating Systemic Risk 2014




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First wave of escalating tremorsEnergy 24 Jun

The Canary: Energy Bull Phase Transition

Europe 7 Jul Europe Bull Phase Transition

Oil 9 Jul (jul 2-11)

Commodities 15 Jul

Euro 15 Jul to 4 Sep

Russia, Junk, EM 17 Jul MH 17

JPY/USD 30 Jul

US, Materials, 31 Jul



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Canary in the coal mine: Energy



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Classic contrarianphase transition:

1. Low vol (complacency)

2. Peak prices

3. … and then an outlier



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Predictive stress test: Energy



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Europe Equity Phase Transition



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Europe Equity Phase TransitionThe start of the negative systemic risk cascade…



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Junk is next



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Junk Bonds (JNK) 10 Jul 2014



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Geopolitical shock: MH17 Crash

See http://bit.ly/1j24pIH




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JPY/USD Phase Tansition



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Japanese Yen devaluation“ The dollar rose 0.7 percent to 102.82 yen to cap a nine-day advance thatmarked its longest winning streak against Japan’s currency since March2005. Japan’s currency fell 0.6 percent to 137.71 per euro.” Bloomberg,Bonds Drop as Dollar Gains on Fed; S&P 500 Little Changed, 31 July 2014



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31 July 2014

US Markets infected, equity & junk bonds



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September-Oct 2014 Wave

JPY, GBP, Commod, Oil, Gold 2 Sep

AU, BRL, Asia 8 Sep

Real Estate 12 Sep

Asia 17 Sep

France, Junk 23 Sep

US Equities 25 Sep

Commod, Oil 30 Sep

Materials, Japan 1 Oct USD (up), 3 Oct

Europe 7 Oct

Energy, JNK, JP, EU 9 Oct

Tech, JNK 10 Oct

Energy, Materials 13 Oct



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2 Sep 2014

Next wave of outliers



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Europe trades down with oil

… while US stays at peak levels for a while longer



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25 Sep 2014: US infected

Start of the most recent downside wave



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17 Oct 2017 - Fed to the Rescue

“… the markets’ impressive countermoves on Friday werewidely attributed to a single factor -- reassuring words fromFederal Reserve officials…” (El-Erian)

http://www.bloombergview.com/articles/2014-10-20/4-lessons-of-a-wild-market-week

http://www.bloomberg.com/news/2014-10-17/bullard-challenges-fed-to-respond-to-weakening-inflation.html



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Reverse Stress TestingWhat conditions give rise to extreme portfolio losses?



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9 Oct 2014



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Survey Question

What risk scenarios are you most concerned about now

1) Fed Tapering

2) Equity bubble

3) Housing bubble

4) Bond bubble

5) Broad asset bubble



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Summary: Financial Cartography

Improve risk models by representing

interconnectivity

Simplify complexity by filtering signal from noise

Key steps: What’s a relevant map for you?

Where are you on the map?Where do you want to go?



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Summary & Conclusions



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Adaptive Stress Testing: harness socialintelligence

1. Stress Library from Thought Leaders

• Create StressIndex with key driving factors

• Use Financial Cartography to build intuition on connected risks

2. Monitor Early Warning Signals (Outliers)

• Focus on key systemic fault lines: what nodes are most likely

to be affected by cascading risk?

• Apply severe predictive shocks to key nodes



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Maps are essential for any Command Center: amplifyintelligence, build intuition, and manage systemic risk

Google Flu Trends (2013)



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Mass collaboration platforms empowersocial intelligence

“ !if you have an idea and I have an idea and we exchange them,

then we both have two ideas. It's nonzero.“ -- Dean Kamen

(“Abundance” by Diamandis & Kotler)

facebook graph of social relationships



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Conclusions

• An era of systemic risk: everything is connected

• Develop visual intuition with Financial

Cartography

• Spark an evolutionary leap in risk culture with

collaborative intelligence platforms

The future is already here. It’s just not very evenly

distributed. - William Gibson



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FNA

Alan Laubsch

Director & VP of Risk Products

[email protected] www.fna.fi

Questions?

http://www.fna.fi/

mailto:[email protected]



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Adaptive Stress PRMIA Webinar Final

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