Glossary: Risk Management Terms
Glossary: Risk Management Terms
This glossary provides definitions for key terms used in derivatives risk management and hedging. Terms are organized alphabetically for quick reference.
A-D
Backtesting
Comparing model predictions (such as VaR) to actual historical outcomes to validate model accuracy.
Basis
The difference between the price of a hedging instrument and the price of the underlying exposure being hedged.
Basis Risk
The risk that a hedge will not move in perfect correlation with the exposure, leaving residual risk.
Beta
A measure of an asset's sensitivity to market movements, where beta of 1.0 means the asset moves with the market.
Concentration Risk
The risk arising from overexposure to a single counterparty, instrument, or market.
Convexity
The second-order sensitivity of bond prices to interest rate changes, measuring how duration itself changes as rates move.
Counterparty Risk
The risk that the other party to a derivatives contract may default on its obligations.
Credit Support Annex (CSA)
A legal document governing collateral arrangements between OTC derivatives counterparties.
Current Exposure
The positive mark-to-market value of a derivatives position, representing what would be lost if the counterparty defaulted today.
Delta
The first-order sensitivity of an option's price to changes in the underlying asset price.
Delta Hedging
A strategy that maintains a delta-neutral position by adjusting the hedge as the underlying price changes.
Duration
A measure of interest rate sensitivity, representing the approximate percentage change in bond price for a 1% change in yield.
DV01 (Dollar Value of 01)
The change in portfolio value for a one basis point (0.01%) move in interest rates.
Dynamic Hedging
A hedging approach that continuously adjusts positions to maintain hedge effectiveness as market conditions change.
E-H
Effectiveness (Hedge)
The degree to which changes in the hedge value offset changes in the hedged exposure value.
Expected Exposure (EE)
The average exposure over the life of a derivatives position, accounting for potential future market moves.
Expected Shortfall (ES)
Also called Conditional VaR or CVaR; the average loss beyond the VaR threshold.
Exposure
The potential financial loss from an adverse market movement or counterparty default.
Gamma
The rate of change of delta with respect to the underlying asset price; measures convexity of options positions.
Gamma Scalping
A trading strategy that profits from rebalancing delta hedges when the underlying price moves.
Greeks
Sensitivity measures for options and derivatives, including Delta, Gamma, Theta, Vega, and Rho.
Haircut
A percentage reduction applied to the market value of collateral to account for potential price declines.
Hedge Accounting
Accounting treatment that matches the timing of hedge gains/losses with the hedged exposure to reduce P&L volatility.
Hedge Ratio
The proportion of an exposure that is covered by a hedging instrument.
I-M
Initial Margin (IM)
Collateral posted at trade inception to cover potential future exposure between margin calls.
Interest Rate Risk
The risk of loss from changes in interest rates affecting the value of fixed income instruments or derivatives.
Liquidity Risk
The risk of being unable to execute trades or meet margin obligations due to lack of market liquidity or available funds.
Mark-to-Market (MTM)
Valuing a position at current market prices rather than historical cost.
Margin Call
A demand for additional collateral when the mark-to-market value of positions moves against the holder.
Marginal VaR
The change in portfolio VaR from adding one additional unit of a position.
Minimum Transfer Amount (MTA)
The smallest collateral movement that will be made under a CSA.
Model Risk
The risk of loss arising from using incorrect or inappropriately applied models for valuation or risk measurement.
N-R
Notional Amount
The face value or reference amount used to calculate payments on a derivative, not necessarily the amount at risk.
Overlay Strategy
A derivatives-based strategy layered on top of an existing portfolio to modify its characteristics.
Potential Future Exposure (PFE)
The maximum expected exposure at a future date at a specified confidence level.
Rebalancing
Adjusting hedge positions to maintain target hedge ratios or risk levels.
Residual Risk
The risk remaining after hedging, due to basis risk, model error, or incomplete hedging.
Rho
The sensitivity of an option's price to changes in interest rates.
Risk Limit
A quantitative constraint on risk-taking, such as maximum VaR, notional, or counterparty exposure.
Roll Risk
The risk of adverse price changes when replacing expiring derivatives with new contracts.
S-T
Sensitivity Analysis
Measuring how portfolio value changes in response to movements in individual risk factors.
SIMM (Standard Initial Margin Model)
An industry-standard methodology for calculating initial margin on uncleared derivatives.
Static Hedging
A hedging approach where positions are established and held without adjustment until maturity.
Stress Testing
Evaluating portfolio performance under extreme but plausible market scenarios.
Tail Risk
The risk of extreme losses beyond what normal probability distributions would predict.
Theta
The sensitivity of an option's price to the passage of time (time decay).
Threshold
Under a CSA, the exposure level below which no collateral is required.
Tracking Error
The standard deviation of the difference between portfolio returns and benchmark returns.
V-Z
Value at Risk (VaR)
A statistical measure of the maximum expected loss over a specified time period at a given confidence level.
Variation Margin (VM)
Collateral exchanged daily to reflect changes in the mark-to-market value of derivatives positions.
Vega
The sensitivity of an option's price to changes in implied volatility.
Volatility
A measure of the dispersion of returns for a given security or market index, often measured as standard deviation.
Wrongway Risk
The risk that counterparty exposure increases at the same time as the counterparty's credit quality deteriorates.
Abbreviations
| Abbreviation | Full Term |
|---|---|
| CSA | Credit Support Annex |
| CVaR | Conditional Value at Risk |
| DV01 | Dollar Value of 01 |
| EE | Expected Exposure |
| ES | Expected Shortfall |
| IM | Initial Margin |
| MTM | Mark-to-Market |
| MTA | Minimum Transfer Amount |
| OTC | Over-the-Counter |
| PFE | Potential Future Exposure |
| SIMM | Standard Initial Margin Model |
| VaR | Value at Risk |
| VM | Variation Margin |
This glossary is updated periodically. For detailed explanations and examples, see the related articles linked below.
Related articles:
- For delta hedging, see Delta Hedging Basics
- For gamma strategies, see Gamma Scalping and Volatility Trading
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