Market Risk

Market risk is incurred primarily through UBS’s trading activities, which are centered in the Investment Bank Business Group. As mentioned in our second quarter 2004 report and implemented in third quarter 2004, the Value at Risk (VaR) model has been modified to more accurately represent the risk of highly rated securitized assets, resulting in a significant reduction in reported VaR. All numbers in this report are based on the new model.

During fourth quarter, the US dollar continued to fall against major currencies, driven by concerns regarding the US current account deficit and oil prices. Towards the end of the quarter, energy prices, in particular oil, started to decline as a result of reduced demand for heating oil. Following the results of the US election and as a consequence of better-than-expected corporate earnings reports, equity markets performed strongly. In fixed income markets, the major yield curves continued to flatten out over the quarter and credit spreads tightened towards the end of the year.

Market risk for the Investment Bank, as measured by the average 10-day 99% VaR, was CHF 358 million in fourth quarter 2004, down from an average of CHF 376 million in the previous quarter. The VaR range was greater than in previous quarters, reflecting our decisions to both reduce risk during periods of uncertainty, such as the run up to the US elections in November, and increase risk when good trading opportunities arose. Interest rate risk, particularly related to credit spreads, continued to be the main contributor to VaR, while equities VaR fell at the end of the quarter as a result of the satisfactory conclusion of a number of arbitrage strategies.

Backtesting compares actual revenues arising from closing positions (i. e. excluding intra-day revenues, fees and commissions) with the 1-day VaR calculated on these positions, and is used to monitor the quality of the VaR model. The graph below left shows these daily backtesting revenues and the corresponding 1-day VaR over the last 12 months. The 10-day VaR, which is the basis of the limits and exposures in the table above, is also shown in this graph for information. Revenue volatility over the period was within the range predicted by the VaR model.

We also routinely assess and actively manage / control tail risks against a standard set of forward-looking scenarios supplemented by specific scenarios targeting individual sectors or reflecting current concerns, such as widening credit spreads or increased energy market volatility. Stress events modeled in our standard scenarios include crises in equity, corporate bond and emerging markets, and severe movements in currency, interest rate and energy markets. These scenarios are reviewed regularly and fine-tuned as necessary. Both average and quarter-end stress loss exposures were slightly lower than in the previous quarter and exposures remained within the approved limits.

VaR and stress measures control our overall portfolio exposure but we also apply concentration controls on exposure to individual market risk variables, such as individual equity markets, currency, interest and foreign exchange rates, and single name issuers. The avoidance of undue risk concentrations remains a key pillar of our risk control process.