JP Morgan Chase 2009 Annual Report Download - page 128

Management’s discussion and analysis
JPMorgan Chase & Co./2009 Annual Report
126
MARKET RISK MANAGEMENT
Market risk is the exposure to an adverse change in the market
value of portfolios and financial instruments caused by a change in
market prices or rates.
Market risk management
Market Risk is an independent risk management function, aligned
primarily with each of the Firm’s business segments. Market Risk
works in partnership with the business segments to identify and
monitor market risks throughout the Firm as well as to define
market risk policies and procedures. The risk management function
is headed by the Firm’s Chief Risk Officer.
Market Risk seeks to facilitate efficient risk/return decisions,
reduce volatility in operating performance and make the Firm’s
market risk profile transparent to senior management, the Board
of Directors and regulators. Market Risk is responsible for the
following functions:
• Establishing a comprehensive market risk policy framework
• Independent measurement, monitoring and control of business
segment market risk
• Definition, approval and monitoring of limits
• Performance of stress testing and qualitative risk assessments
Risk identification and classification
Each business segment is responsible for the comprehensive identi-
fication and verification of market risks within its units. The highest
concentrations of market risk are found in IB, Consumer Lending,
and the Firm’s Chief Investment Office in the Corporate/Private
Equity segment.
IB makes markets and trades its products across several different
asset classes. These asset classes primarily include fixed income risk
(both interest rate risk and credit spread risk), foreign exchange,
equities and commodities risk. These trading risks may lead to the
potential decline in net income due to adverse changes in market
rates. In addition to these trading risks, there are risks in IB’s credit
portfolio from retained loans and commitments, derivative credit
valuation adjustments, hedges of the credit valuation adjustments
and mark-to-market hedges of the retained loan portfolio. Addi-
tional risk positions result from the debit valuation adjustments
taken on certain structured liabilities and derivatives to reflect the
credit quality of the Firm.
The Firm’s Consumer Lending business unit includes the Firm’s
mortgage pipeline and warehouse loans, MSRs and all related
hedges. These activities give rise to complex interest rate risks, as
well as option and basis risk. Option risk arises primarily from
prepayment options embedded in mortgages and changes in the
probability of newly originated mortgage commitments actually
closing. Basis risk results from differences in the relative move-
ments of the rate indices underlying mortgage exposure and other
interest rates.
The Chief Investment Office is primarily concerned with managing
structural market risks which arise out of the various business
activities of the Firm. These include structural interest rate risk, and
foreign exchange risk. Market Risk measures and monitors the
gross structural exposures as well as the net exposures related to
these activities.
Risk measurement
Tools used to measure risk
Because no single measure can reflect all aspects of market
risk, the Firm uses various metrics, both statistical and nonsta-
tistical, including:
• Nonstatistical risk measures
• Value-at-risk
• Loss advisories
• Drawdowns
• Economic value stress testing
• Earnings-at-risk stress testing
• Risk identification for large exposures (“RIFLE”)
Nonstatistical risk measures
Nonstatistical risk measures other than stress testing include net open
positions, basis point values, option sensitivities, market values,
position concentrations and position turnover. These measures pro-
vide granular information on the Firm’s market risk exposure. They
are aggregated by line of business and by risk type, and are used for
monitoring limits, one-off approvals and tactical control.
Value-at-risk
JPMorgan Chase’s primary statistical risk measure, VaR, estimates
the potential loss from adverse market moves in a normal market
environment and provides a consistent cross-business measure of
risk profiles and levels of diversification. VaR is used for comparing
risks across businesses, monitoring limits, and as an input to eco-
nomic capital calculations. Each business day, as part of its risk
management activities, the Firm undertakes a comprehensive VaR
calculation that includes the majority of its market risks. These VaR
results are reported to senior management.