Morgan Stanley 1999 Annual Report Download - page 52

99 AR |page 50 cation; and can cover a wide range of portfolio assets yet are rela-
tively easy to interpret. However, VaR risk measures should be inter-
preted in light of the methodology’s limitations, which include the
following: past changes in market risk factors will not always yield
accurate predictions of the distributions and correlations of future
market movements; changes in portfolio value in response to mar-
ket movements may differ from the responses calculated by a VaR
model; published VaR results reflect past trading positions while
future risk depends on future positions; VaR using a one-day time
horizon does not fully capture the market risk of positions that can-
not be liquidated or hedged within one day; and the historical mar-
ket risk factor data used for VaR estimation may provide only
limited insight into losses that could be incurred under market con-
ditions that are unusual relative to the historical period used in esti-
mating the VaR. The Company is aware of these and other
limitations and therefore uses VaR as only one component in its risk
management review process. This process also incorporates stress
testing and extensive risk monitoring and control at the trading
desk, division and Company levels.
VaR for Fiscal 1999
The table below presents the results of the Company’s VaR for each
of the Company’s primary market risk exposures and on an aggregate
basis at November 30, 1999 and November 30, 1998, incorporat-
ing substantially all financial instruments generating market risk
(including funding liabilities related to trading positions, retail trad-
ing activities and private equity positions). However, a small pro-
portion of trading positions generating market risk was not covered,
and the modeling of the risk characteristics of some positions
involved approximations which could be significant under certain
circumstances. Market risks that are in the VaR values shown in the
following table, but that the Company has found particularly diffi-
cult to model, include certain fixed income instruments (such as
aspects of prepayment behavior of mortgage-backed securities and
credit derivatives price risk), name-specific equity price risk in pri-
vate or newly public companies, certain commodity price risks
(such as electricity price risk) and certain liquidity risks.
Since VaR is based on historical data and changes in mar-
ket risk factor returns, VaR should not be viewed as predictive of
the Company’s future financial performance or its ability to moni-
tor and manage risk, and there can be no assurance that the
Company’s actual losses on a particular day will not exceed the VaR
amounts indicated below or that such losses will not occur more
than once in 100 trading days.
99%/ONE-DAY VaR
PRIMARY MARKET RISK CATEGORY AT NOVEMBER 30,
(dollars in millions, pre-tax) 1999 1998(1)
Interest rate $33 $28
Equity price 32 17
Foreign exchange rate 3 5
Commodity price 16 6
Subtotal 84 56
Less diversification benefit(2) 33 18
Aggregate Value-at-Risk $51 $38
(1) The Interest rate Value-at-Risk for fiscal 1998 has been restated to reflect the esti-
mated impact of enhancements to the Company’s VaR model made during fiscal
1999 described above.
(2) Equals the difference between Aggregate VaR and the sum of the VaRs for the four
risk categories. This benefit arises because the simulated 99%/one-day losses for
each of the four primary market risk categories occur on different days; similar diver-
sification benefits also are taken into account within each such category.
The change in Interest rate VaR from November 30, 1998 to
November 30, 1999 reflected, in part, an increase in certain high-
yield and emerging market interest rate risk positions. The change in
Equity price VaR from November 30, 1998 to November 30, 1999
reflected, in part, an increase in the market value of certain private
equity positions, a substantial portion of which was sold by the
Company shortly after the end of the fiscal year. The change in
Commodity price VaR reflected, in part, higher market values of com-
modities positions arising from increases in energy prices throughout
the year.
In order to facilitate comparisons with other global finan-
cial services firms, the Company notes that its Aggregate VaR at
November 30, 1999 for other confidence levels and time horizons
was as follows: $32 million for 95%/one-day VaR and $151 million
for 99%/two-week VaR.