Sensitivities-Based Method and Expected Shortfall for Market Risk Under FRTB and Its Impact on Options Risk Capital

The changes in the Basel FRTB regulation come into effect in 2023 and will expose banking institutions to new challenges in terms of implementation, risk quantification and impacts on capital requirements. This paper first suggests an algorithm for implementing the FRTB standardised approach via the sensitivities-based method to estimate a portfolio's market risk capital and presents an illustration applied to an option position. Second, it proposes a methodology to estimate the expected shortfall in options portfolios from the FRTB internal models approach. In this regard, an application is developed to measure ES and VaR's impacts under FRTB vs conventional VaR in a currency option position by considering stress scenarios from the 2007-9 and 2020-1 crises and back-testing procedures. The proposals developed weave a communication bridge between the FRTB standardised and internal approaches that can be scaled up institutionally