JP Morgan Chase 2014 Annual Report Download - page 183

JPMorgan Chase & Co./2014 Annual Report 181
• Unobservable parameter valuation adjustments may be
made when positions are valued using prices or input
parameters to valuation models that are unobservable
due to a lack of market activity or because they cannot
be implied from observable market data. Such prices or
parameters must be estimated and are, therefore,
subject to management judgment. Unobservable
parameter valuation adjustments are applied to reflect
the uncertainty inherent in the resulting valuation
estimate.
Where appropriate, the Firm also applies adjustments to its
estimates of fair value in order to appropriately reflect
counterparty credit quality, the Firm’s own creditworthiness
and the impact of funding, applying a consistent framework
across the Firm. For more information on such adjustments
see Credit and funding adjustments on pages 196–197 of
this Note.
Valuation model review and approval
If prices or quotes are not available for an instrument or a
similar instrument, fair value is generally determined using
valuation models that consider relevant transaction data
such as maturity and use as inputs market-based or
independently sourced parameters. Where this is the case
the price verification process described above is applied to
the inputs to those models.
The Model Risk function is independent of the model owners
and reviews and approves a wide range of models, including
risk management, valuation and certain regulatory capital
models used by the Firm. The Model Risk function is part of
the Firm’s Model Risk and Development unit, and the
Firmwide Model Risk and Development Executive reports to
the Firm’s CRO. When reviewing a model, the Model Risk
function analyzes and challenges the model methodology
and the reasonableness of model assumptions and may
perform or require additional testing, including back-testing
of model outcomes.
New significant valuation models, as well as material
changes to existing valuation models, are reviewed and
approved prior to implementation except where specified
conditions are met. The Model Risk function performs an
annual firmwide model risk assessment where
developments in the product or market are considered in
determining whether valuation models which have already
been reviewed need to be reviewed and approved again.
Valuation hierarchy
A three-level valuation hierarchy has been established
under U.S. GAAP for disclosure of fair value measurements.
The valuation hierarchy is based on the transparency of
inputs to the valuation of an asset or liability as of the
measurement date. The three levels are defined as follows.
• Level 1 – inputs to the valuation methodology are
quoted prices (unadjusted) for identical assets or
liabilities in active markets.
• Level 2 – inputs to the valuation methodology include
quoted prices for similar assets and liabilities in active
markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the
full term of the financial instrument.
• Level 3 – one or more inputs to the valuation
methodology are unobservable and significant to the fair
value measurement.
A financial instrument’s categorization within the valuation
hierarchy is based on the lowest level of input that is
significant to the fair value measurement.