Business and Management

Financial risk management

Professor Carol Alexander’s research on financial risk management is being used by the Intercontinental Exchange to develop a new breed of models for determining margins on derivatives trades. The Intercontinental Exchange, Inc. (ICE) is a global network of exchanges and clearing houses for financial and commodity markets.

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Transactions on financial derivatives are leveraged, meaning that the purchases do not need to pay the whole notional amount up front, only a small fraction of this amount, which is called the margin. Financial markets today are driven by changes in regulations, much more than before the banking crisis. For instance, new regulations require all derivatives trades to be cleared by a central counterparty; and related to this are some other new regulations on minimum margins that are receiving considerable attention from academics, regulators and the exchanges that host the clearing houses.

European Regulations (EMIR) are driving exchanges to move away from the Standard Portfolio Analysis Tool (SPAN) that they have used to use to determine margins for more than 20 years. With about $500 trillion notional outstanding, the margining on interest rate swaps is a particularly important problem for banks, especially since these transactions must now cleared through a central counterparty.

Professor Carol Alexander currently has a research grant from the Global Risk Institute, with Dr. Andreas Kaeck and Dr. Annanit Sumawong to develop new margining models. Professor Alexander is managing editor of one of the largest finance journals, the Journal of Banking and Finance and author of a 4-volume textbook series Market Risk Analysis which provides the basics to the most advanced level of understanding of market risk analysis, a self-study program, and spreadsheets for developing software for financial services. This work, notably the fourth volume Value-at-Risk Models book, has been used by the Intercontinental Exchange to design a new margin model for interest rate swaps. Professor Alexander is responsible for validating the model.