Goldman Sachs 2012 Annual Report Download - page 42

Management’s Discussion and Analysis
Price Verification. All financial instruments at fair value in
levels 1, 2 and 3 of the fair value hierarchy are subject to
our independent price verification process. The objective of
price verification is to have an informed and independent
opinion with regard to the valuation of financial
instruments under review. Instruments that have one or
more significant inputs which cannot be corroborated by
external market data are classified within level 3 of the fair
value hierarchy. Price verification strategies utilized by our
independent control and support functions include:
‰Trade Comparison.Analysis of trade data (both internal
and external where available) is used to determine the
most relevant pricing inputs and valuations.
‰External Price Comparison.Valuations and prices are
compared to pricing data obtained from third parties (e.g.,
broker or dealers, MarkIt, Bloomberg, IDC, TRACE).
Data obtained from various sources is compared to ensure
consistency and validity. When broker or dealer quotations
or third-party pricing vendors are used for valuation or
price verification, greater priority is generally given to
executable quotations.
‰Calibration to Market Comparables.Market-based
transactions are used to corroborate the valuation of
positions with similar characteristics, risks and components.
‰Relative Value Analyses.Market-based transactions
are analyzed to determine the similarity, measured in
terms of risk, liquidity and return, of one instrument
relative to another or, for a given instrument, of one
maturity relative to another.
‰Collateral Analyses.Margin disputes on derivatives are
examined and investigated to determine the impact, if
any, on our valuations.
‰Execution of Trades.Where appropriate, trading desks
are instructed to execute trades in order to provide
evidence of market-clearing levels.
‰Backtesting.Valuations are corroborated by
comparison to values realized upon sales.
See Notes 5 through 8 to the consolidated financial
statements for further information about fair value
measurements.
Review of Net Revenues. Independent control and
support functions ensure adherence to our pricing policy
through a combination of daily procedures, including the
explanation and attribution of net revenues based on the
underlying factors. Through this process we independently
validate net revenues, identify and resolve potential fair value
or trade booking issues on a timely basis and seek to ensure
that risks are being properly categorized and quantified.
Review of Valuation Models. The firm’s independent
model validation group, consisting of quantitative
professionals who are separate from model developers,
performs an independent model approval process. This
process incorporates a review of a diverse set of model and
trade parameters across a broad range of values (including
extreme and/or improbable conditions) in order to
critically evaluate:
‰the model’s suitability for valuation and risk management
of a particular instrument type;
‰the model’s accuracy in reflecting the characteristics of
the related product and its significant risks;
‰the suitability of the calculation techniques incorporated
in the model;
‰the model’s consistency with models for similar
products; and
‰the model’s sensitivity to input parameters and
assumptions.
New or changed models are reviewed and approved prior
to being put into use. Models are evaluated and re-
approved annually to assess the impact of any changes in
the product or market and any market developments in
pricing theories.
40 Goldman Sachs 2012 Annual Report