Market Risk refers to the potential for losses arising from negative changes in the value of an asset. These changes include fluctuations in share prices, interest rates, foreign exchange rates, commodity prices, real estate prices, market or asset specific volatility and credit spreads. Asset liquidity risk is closely tied with market risk and represents the risk that an entity will be unable to unwind a position in a particular financial instrument at, or near, its market value because of lack of depth or disruption in the market for that given instrument.
The European Banking Authority (EBA) defined market risk as:
Market risk can be defined as the risk of losses in on and off-balance sheet positions arising from adverse movements in market prices. From a regulatory perspective, market risk stems from all the positions included in banks’ trading book as well as from commodity and foreign exchange risk positions in the whole balance sheet. Traditionally, trading book portfolios consisted of liquid positions easy to trade or hedge. However, developments in banks’ portfolios have led to an increase in the presence of credit risk and illiquid positions not suited to the original market capital framework. To address these flaws, material changes in the market risk framework (generally known as ‘Basel 2.5′) have been introduced by the CRD III. The EBA, through the publication of its guidelines intend to foster convergence in the implementation of some of these new capital requirements, namely the stressed value at risk (stressed VaR) and the incremental risk charge (IRC) introduced to adequately capture credit risk. The EBA will also draft some draft regulatory standards (RTS) to clarify and better articulate some requirements provided for in the new CRDIV/CRR text.
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