How the Trading Floor Really Works

Risk Management Models and What They Do

Risk management models are different from pricing models. Risk management models are used to help the bank quantify risk and allocate capital. They are also used to set up risk limits and risk monitoring systems as well as to help traders better understand and manage the risks in their trading books. Big picture, the question that risk management models are meant to answer is “How much can we lose?” Trading books take risk by providing a service to their clients. Traders make markets and end up buying or selling something which they can’t always immediately or perfectly hedge. What risk management models do is to help the bank figure out, based on different historical analysis and different possible market ...