Goldman Sachs 2013 Annual Report Download - page 93

Management’s Discussion and Analysis
We are aware of the inherent limitations to VaR and
therefore use a variety of risk measures in our market risk
management process. Inherent limitations to VaR include:
‰VaR does not estimate potential losses over longer time
horizons where moves may be extreme.
‰VaR does not take account of the relative liquidity of
different risk positions.
‰Previous moves in market risk factors may not produce
accurate predictions of all future market moves.
When calculating VaR, we use historical simulations with
full valuation of approximately 70,000 market factors.
VaR is calculated at a position level based on
simultaneously shocking the relevant market risk factors
for that position. We sample from 5 years of historical data
to generate the scenarios for our VaR calculation. The
historical data is weighted so that the relative importance of
the data reduces over time. This gives greater importance to
more recent observations and reflects current asset
volatilities, which improves the accuracy of our estimates of
potential loss. As a result, even if our positions included in
VaR were unchanged, our VaR would increase with
increasing market volatility and vice versa.
Given its reliance on historical data, VaR is most effective in
estimating risk exposures in markets in which there are no
sudden fundamental changes or shifts in market conditions.
Our VaR measure does not include:
‰positions that are best measured and monitored using
sensitivity measures; and
‰the impact of changes in counterparty and our own credit
spreads on derivatives, as well as changes in our own
credit spreads on unsecured borrowings for which the fair
value option was elected.
Stress Testing
Stress testing is a method of determining the effect on the
firm of various hypothetical stress scenarios. We use stress
testing to examine risks of specific portfolios as well as the
potential impact of significant risk exposures across the
firm. We use a variety of stress testing techniques to
calculate the potential loss from a wide range of market
moves on the firm’s portfolios, including sensitivity
analysis, scenario analysis and firmwide stress tests. The
results of our various stress tests are analyzed together for
risk management purposes.
Sensitivity analysis is used to quantify the impact of a
market move in a single risk factor across all positions (e.g.,
equity prices or credit spreads) using a variety of defined
market shocks, ranging from those that could be expected
over a one-day time horizon up to those that could take
many months to occur. We also use sensitivity analysis to
quantify the impact of the default of a single corporate
entity, which captures the risk of large or
concentrated exposures.
Scenario analysis is used to quantify the impact of a
specified event, including how the event impacts multiple
risk factors simultaneously. For example, for sovereign
stress testing we calculate potential direct exposure
associated with our sovereign inventory as well as the
corresponding debt, equity and currency exposures
associated with our non-sovereign inventory that may be
impacted by the sovereign distress. When conducting
scenario analysis, we typically consider a number of
possible outcomes for each scenario, ranging from
moderate to severely adverse market impacts. In addition,
these stress tests are constructed using both historical events
and forward-looking hypothetical scenarios.
Firmwide stress testing combines market, credit,
operational and liquidity risks into a single combined
scenario. Firmwide stress tests are primarily used to assess
capital adequacy as part of our capital planning and stress
testing process; however, we also ensure that firmwide
stress testing is integrated into our risk governance
framework. This includes selecting appropriate scenarios to
use for our capital planning and stress testing process. See
“Equity Capital — Capital Planning and Stress Testing
Process” above for further information.
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