JP Morgan Chase 2015 Annual Report Download - page 205

JPMorgan Chase & Co./2015 Annual Report 195
Correlation – Correlation is a measure of the relationship
between the movements of two variables (e.g., how the
change in one variable influences the change in the other).
Correlation is a pricing input for a derivative product where
the payoff is driven by one or more underlying risks.
Correlation inputs are related to the type of derivative (e.g.,
interest rate, credit, equity and foreign exchange) due to
the nature of the underlying risks. When parameters are
positively correlated, an increase in one parameter will
result in an increase in the other parameter. When
parameters are negatively correlated, an increase in one
parameter will result in a decrease in the other parameter.
An increase in correlation can result in an increase or a
decrease in a fair value measurement. Given a short
correlation position, an increase in correlation, in isolation,
would generally result in a decrease in a fair value
measurement. The range of correlation inputs between
risks within the same asset class are generally narrower
than those between underlying risks across asset classes. In
addition, the ranges of credit correlation inputs tend to be
narrower than those affecting other asset classes.
The level of correlation used in the valuation of derivatives
with multiple underlying risks depends on a number of
factors including the nature of those risks. For example, the
correlation between two credit risk exposures would be
different than that between two interest rate risk
exposures. Similarly, the tenor of the transaction may also
impact the correlation input as the relationship between the
underlying risks may be different over different time
periods. Furthermore, correlation levels are very much
dependent on market conditions and could have a relatively
wide range of levels within or across asset classes over
time, particularly in volatile market conditions.
Volatility – Volatility is a measure of the variability in
possible returns for an instrument, parameter or market
index given how much the particular instrument, parameter
or index changes in value over time. Volatility is a pricing
input for options, including equity options, commodity
options, and interest rate options. Generally, the higher the
volatility of the underlying, the riskier the instrument. Given
a long position in an option, an increase in volatility, in
isolation, would generally result in an increase in a fair
value measurement.
The level of volatility used in the valuation of a particular
option-based derivative depends on a number of factors,
including the nature of the risk underlying the option (e.g.,
the volatility of a particular equity security may be
significantly different from that of a particular commodity
index), the tenor of the derivative as well as the strike price
of the option.
EBITDA multiple – EBITDA multiples refer to the input (often
derived from the value of a comparable company) that is
multiplied by the historic and/or expected earnings before
interest, taxes, depreciation and amortization (“EBITDA”) of
a company in order to estimate the company’s value. An
increase in the EBITDA multiple, in isolation, net of
adjustments, would result in an increase in a fair value
measurement.
Changes in level 3 recurring fair value measurements
The following tables include a rollforward of the
Consolidated balance sheets amounts (including changes in
fair value) for financial instruments classified by the Firm
within level 3 of the fair value hierarchy for the years ended
December 31, 2015, 2014 and 2013. When a
determination is made to classify a financial instrument
within level 3, the determination is based on the
significance of the unobservable parameters to the overall
fair value measurement. However, level 3 financial
instruments typically include, in addition to the
unobservable or level 3 components, observable
components (that is, components that are actively quoted
and can be validated to external sources); accordingly, the
gains and losses in the table below include changes in fair
value due in part to observable factors that are part of the
valuation methodology. Also, the Firm risk-manages the
observable components of level 3 financial instruments
using securities and derivative positions that are classified
within level 1 or 2 of the fair value hierarchy; as these level
1 and level 2 risk management instruments are not
included below, the gains or losses in the following tables
do not reflect the effect of the Firm’s risk management
activities related to such level 3 instruments.