Earnings Risk
Earnings at Risk versus VaR
Corporations involved with real assets, physical commodities and products, versus financial instruments, often have a large portion of the "production" portfolio that is not locked and is at floating prices. These typically do not undergo Value at Risk valuation. However, the cash flow of these positions and the ensuing earnings have tremendous volatility, especially when these are projected forward over longer horizons, such as quarterly or yearly.
QR Risk Server offers a unique capability to model and project forward via Monte Carlo simulations, the Cash Flow and Earnings of your portfolios, businesses and assets at any income statement you desire. We offer detailed templates for cash flow and earnings modeling, or can integrate your in-house earnings statements and simulate around them to create at risk values.
Stress Testing
The Monte Carlo engine performs comprehensive stress testing of market price levels and volatility as well as portfolio positions. Unlike most risk systems, we do not just shock the forward curves and leave volatility and correlations intact. All facets of the entire Monte Carlo engine may be adjusted and resimulated at run time.
Dynamic Portfolio Modeling
No portfolio structure is pre-set unlike traditional risk systems which only allow for a determined structure often organized in a few commodity or division books. Irrespective on how your transactions were captured, the Risk Server has a dynamic portfolio builder that allows you to rapidly configure any desired multi-layered embedded portfolio structure for them.
Valuation is done recursively across the entire portfolio structure, using the same sets of simulated price and volume sample paths. You can then view risk results marginally at given portfolio levels, using drill-down and roll-up up capability for aggregation. Since valuation is based on correlated sample paths of all basic random processes (prices and volumes), correlation across portfolio layers is implicit.
Multiple Currencies
The system models stochastically and simulates the FX (and corresponding interest rates) of all transactions and evaluates your portfolio in any desired currency on the fly. While Settlement is done in the native currency of the float of a deal, when performing MTM and Risk, you can switch, for consolidated view, to any currency you desire, and save the results for reference. For example, you can have your entire portfolio evaluated at the same time in US $, and in Euro, etc.
Full Control During valuation
When simulating Earnigs at Risk some of the features you can set or control are:
- Holding Period can be as long as many years for Cash Flow at Risk.
- Number of Monte Carlo simulations used to form a probability distribution.
- Percentile or Risk level (95% to 99%) at which risk statistics are to be computed and displayed.
Aggregation and Time Bucketing
You can use time-bucket valuation to see your risk in weekly, monthly, quarterly, or yearly blocks. You can thus optimize and/or hedge your portfolio. E.g., monthly blocks allow you to hedge excessive Earnigs at Risk via forwards or futures. This additional dimension allows you to compute and display risk for a bucket across portfolio levels or vice versa. You can also integrate risk values Forward as cash flow accumulates, or Backward as positions unwind.
Risk Metrics
For Earnigs Risk, the following risk metrics are computed by Monte Carlo simulation:
- MTM and P&L
- Cash Flow at Risk and Earnings at Risk (at any income statement you desire)
Risk Matrix. The system offers the most comprehensive display of risk statistics and visualization. For every indicator among the above Risk Metrics, the full distribution is generated and the following statistics are computed at any desired percentile, on a daily basis until the end of the time horizon:
| Expected Loss | Tail Risk |
Mean or Expected Value |
Tail Gain |
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The average below the red risk tail of the distribution. This is the average amount you could lose if the worst case occurs. This stat is called CEaR (Conditional EaR) as it is the average value conditional on the value being below the red line. For skewed prices such as electricity it can be significantly lower than the risk percentile. So Conditional EaR is often more meaningful than EaR. |
This is the worst case scenario or the lower percentile of the distribution, shown in red. If risk level is 95% it means that 5% of the time (or 1 time out of 20) value will fall below the red line. A useful number is Cash Flow and Earnigs at Risk computed by the difference of green and red lines: EaR = Mean - Tail Risk |
This is the expected future cash Flow / Earnings of your portfolio. It is also the mean value of the distribution at all moments in time. Note the green line is also the forecasted settled values of your portfolio at all times. Risk engine centers sample paths around values predicted by settlement module. So risk and MTM are always consistent. |
This is the up side or the higher percentile of the distribution, shown in light blue. It represents the upside or best case scenario. (Similar to Tail Risk, except in reverse) If risk level is 95% it means that 5% of the time (or 1 time out of 20) value will be above the light blue line. |
| Cash Flow / Earnings Risk Plot Aggregated through Time | Cash Flow / Earnings Risk Plot by Monthly Time Buckets |
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