Academic journal article Informatica Economica

The Architecture of Financial Risk Management Systems

Academic journal article Informatica Economica

The Architecture of Financial Risk Management Systems

Article excerpt

The architecture of systems dedicated to risk management is probably one of the more complex tasks to tackle in the world of finance. Financial risk has been at the center of attention since the explosive growth of financial markets and even more so after the 2008 financial crisis. At multiple levels, financial companies, financial regulatory bodies, governments and cross-national regulatory bodies, all have put the subject of financial risk in particular and the way it is calculated, managed, reported and monitored under intense scrutiny. As a result the technology underpinnings which support the implementation of financial risk systems has evolved considerably and has become one of the most complex areas involving systems and technology in the context of the financial industry. We present the main paradigms, requirements and design considerations when undertaking the implementation of risk system and give examples of user requirements, sample product coverage and performance parameters.

Keywords: Financial Risk Systems, Cross Asset, Distributed Global Implementation

1 Introduction

The world of finance of today is an extremely complex habitat which has become increasingly difficult to estimate, manage and control. The complexity of the financial environment, interactions and specifically financial products has become such that the most sophisticated tools and systems are required to be able to estimate, quantify, monitor and ultimately control the complex parameters used in estimating the risk associated to the financial industry's activities. This is a subject that can be extremely daunting to approach in a limited space but a very high level overview is nonetheless possible. Over the past 30 years, the development and wide spread of derivatives has triggered the requirement for more and more complex ways of pricing, organizing and managing such products. Over the course of this time many different approaches have been pursued, some with more and others with less success. Often the challenge in this space is defining the type of risk measures that are to be considered as part of this effort. Since the '80s one key measure of risk has been VaR, or Value at Risk [5], which gave financial institutions a relatively both simple as well as complex way of estimating risk associated with financial instruments. While this measure is still wide-spread, its reliability and "clout" has been greatly damaged by events such as the failure of LTCM (Long Term Capital Management) in 1998 as well as other significant events. While there is a measure of agreement in terms of ways to estimate risk for some instruments, such as for ex. vanilla options [1] and by extension many other similar derived products, many other financial products widely traded in the markets, such as for ex. credit default swaps on mortgage securities, require such complex approaches and assumptions that make them outright difficult and even dangerous, one can say. To this extent, potent authors have come out to speak about the subject of risk and the way it is managed, or rather mismanaged [6] [10]. Some of these authors have predicted the events of 2008 and the reasons for the collapse of some financial institutions and the grand old establishment they had created, but maybe predicting is not necessarily the primary scope of this undertaking, rather just attempt to express how complex and difficult this subject is and to show that it is well deserved to consider that it is important to understand risk, even if ultimately risk is just that, risk, and may not be entirely possible to control, even if understood, as long as the decision is to take that risk.

In an effort to build such systems some pioneers have emerged in the industry. Most of these pioneers came out of institutions such as investment banks. A notable participant may be JPMorgan, which decided to spin out its risk platform and establish an independent company using to products developed within the company [8]. …

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