Goldman Sachs 2013 Annual Report Download - page 94

Management’s Discussion and Analysis
Unlike VaR measures, which have an implied probability
because they are calculated at a specified confidence level,
there is generally no implied probability that our stress test
scenarios will occur. Instead, stress tests are used to model
both moderate and more extreme moves in underlying
market factors. When estimating potential loss, we
generally assume that our positions cannot be reduced or
hedged (although experience demonstrates that we are
generally able to do so).
Stress test scenarios are conducted on a regular basis as part
of the firm’s routine risk management process and on an ad
hoc basis in response to market events or concerns. Stress
testing is an important part of the firm’s risk management
process because it allows us to quantify our exposure to tail
risks, highlight potential loss concentrations, undertake
risk/reward analysis, and assess and mitigate our
risk positions.
Limits
We use risk limits at various levels in the firm (including
firmwide, product and business) to govern risk appetite by
controlling the size of our exposures to market risk. Limits
are set based on VaR and on a range of stress tests relevant
to the firm’s exposures. Limits are reviewed frequently and
amended on a permanent or temporary basis to reflect
changing market conditions, business conditions or
tolerance for risk.
The Firmwide Risk Committee sets market risk limits at
firmwide and product levels and our Securities Division
Risk Committee sets sub-limits for market-making and
investing activities at a business level. The purpose of the
firmwide limits is to assist senior management in
controlling the firm’s overall risk profile. Sub-limits set the
desired maximum amount of exposure that may be
managed by any particular business on a day-to-day basis
without additional levels of senior management approval,
effectively leaving day-to-day trading decisions to
individual desk managers and traders. Accordingly, sub-
limits are a management tool designed to ensure
appropriate escalation rather than to establish maximum
risk tolerance. Sub-limits also distribute risk among various
businesses in a manner that is consistent with their level of
activity and client demand, taking into account the relative
performance of each area.
Our market risk limits are monitored daily by Market Risk
Management, which is responsible for identifying and
escalating, on a timely basis, instances where limits have
been exceeded. The business-level limits that are set by the
Securities Division Risk Committee are subject to the same
scrutiny and limit escalation policy as the firmwide limits.
When a risk limit has been exceeded (e.g., due to changes in
market conditions, such as increased volatilities or changes
in correlations), it is reported to the appropriate risk
committee and a discussion takes place with the relevant
desk managers, after which either the risk position is
reduced or the risk limit is temporarily or
permanently increased.
Model Review and Validation
Our VaR and stress testing models are subject to review and
validation by our independent model validation group at
least annually. This review includes:
‰a critical evaluation of the model, its theoretical
soundness and adequacy for intended use;
‰verification of the testing strategy utilized by the model
developers to ensure that the model functions as
intended; and
‰verification of the suitability of the calculation techniques
incorporated in the model.
Our VaR and stress testing models are regularly reviewed
and enhanced in order to incorporate changes in the
composition of positions included in the firm’s market risk
measures, as well as variations in market conditions. Prior
to implementing significant changes to our assumptions
and/or models, we perform model validation and test runs.
Significant changes to our VaR and stress testing models are
reviewed with the firm’s chief risk officer and chief financial
officer, and approved by the Firmwide Risk Committee.
We evaluate the accuracy of our VaR model through daily
backtesting (i.e., comparing daily trading net revenues to
the VaR measure calculated as of the prior business day) at
the firmwide level and for each of our businesses and major
regulated subsidiaries.
92 Goldman Sachs 2013 Annual Report