Morgan Stanley 1998 Annual Report Download - page 46

*FIFTY *
MORGAN STANLEY DEAN WITTER *1998 ANNUAL REPORT
porating substantially all financial instruments generating market risk
(including funding liabilities related to hedging trading positions, retail
trading activities and certain private equity positions that are not
reported separately because the aggregate impact on the Company’s
VaR was not material). However, a small proportion of trading posi-
tions generating market risk were not covered, and the modeling of
the risk characteristics of some positions involved approximations
which could be significant under certain circumstances. Market
risks that the Company has found particularly difficult to incorporate
in its VaR model include certain risks associated with mortgage-backed
securities, some commodity price risks (such as electricity price
risk) and liquidity risks in certain financial products.
Since VaR is based on historical data and changes in
market risk factor returns, VaR should not be viewed as predictive
of the Company’s future financial performance or its ability to man-
age and monitor 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
AT NOVEMBER 30, PRIMARY MARKET RISK CATEGORY
(dollars in millions, pre-tax) 1998 1997(1)
Interest rate $36 $42
Equity price 17 17
Foreign exchange rate 5 7
Commodity price 6 6
Subtotal 64 72
Less diversification benefit(2) 26 26
Aggregate Value-at-Risk $38 $46
(1)The Interest rate and Aggregate Value-at-Risk for fiscal 1997 have been restated to reflect the esti-
mated impact of enhancements to the Company’s VaR model made during fiscal 1998 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 mar-
ket risk categories occur on different days;similar diversification benefits also are taken into account
within each such category.
The change in Aggregate Value-at-Risk from November 30, 1997 to
November 30, 1998 primarily reflected a reduction in certain inter-
est rate risk positions.
In order to facilitate comparison with other global
financial services firms, the Company notes that its Aggregate VaR
at November 30, 1998 for other confidence levels and time horizons
was as follows: $26 million for 95%/one-day VaR and $121 million
for 99%/two-week VaR.
The table below presents the average, high and low
99%/one-day VaR over the course of fiscal 1998 for substantially
all of the Company’s institutional trading activities. This measure of
VaR incorporates most of the Company’s trading-related market
risks. Certain market risks included in the year-end VaR discussed
above are excluded from this measure (i.e., those associated with
the Company’s retail trading activities, equity price risk in certain
private equity positions and funding liabilities related to hedging
trading positions).
DAILY 99%/ONE-DAY VaR FOR FISCAL 1998PRIMARY MARKET RISK CATEGORY
(dollars in millions, pre-tax) High Low Average
Interest rate $50 $35 $41
Equity price 19 12 15
Foreign exchange rate 10 3 5
Commodity price 8 5 6
Aggregate Value-at-Risk $50 $35 $43
The Company evaluates the reasonableness of its VaR model by com-
paring the potential declines in portfolio values generated by the
model with actual trading results. Despite volatile market conditions
during fiscal 1998, there were no days during which the Company
incurred daily trading losses in its institutional trading business in
excess of the 99%/one-day VaR which incorporates the enhancements
to the Company’s VaR model made during fiscal 1998.
The chart below presents the Company’s daily 99%/one-day VaR for
its institutional trading activities over the course of fiscal 1998:
99% / ONE-DAY VALUE-AT-RISK
first quarter second quarter third quarter fourth quarter
millions of dollars
25
30
35
40
45
50
55
60
20