Risk register · entry
Q4 · Where models dieJPMorgan London Whale
A new risk model halved the danger overnight. It divided by a sum instead of an average.
The world stops matching the model. Regime change and leverage turn a small error fatal.
Why this room
The Synthetic Credit Portfolio tripled in notional size in one quarter to a scale at which the portfolio itself moved the index-tranche prices it was marked against, so the historical relationships underpinning both the hedging thesis and the risk metrics stopped holding. At the same moment the CIO replaced its VaR model with one that cut reported risk roughly in half, so the risk system reported a shrinking exposure while the actual exposure was compounding, and every subsequent limit breach was read as a measurement artefact rather than a signal. This is q4 because the fatal mechanism was model-to-world divergence under leverage: the map was rewritten to fit the position, and the loss arrived through the gap.
The record
- The Synthetic Credit Portfolio lost $6.2 billion in 2012.certain
- The SCP's net notional size tripled in the first quarter of 2012, from $51 billion at end-2011 to $157 billion by 30 March 2012.certain
- The new CIO VaR model, in use from 27 January 2012, cut the CIO's reported VaR by about 50%, from $132 million to $66 million, ending the firm-wide VaR limit breach without a single position being sold.certain
- CIO risk limits and advisories were breached more than 330 times in the first quarter of 2012, including a CS01 limit exceeded by roughly 1,000% for months.certain
- JPMorgan's own Task Force found the model contained an operational error in calculating relative changes in hazard rates and correlations: after subtracting the old rate from the new rate, the spreadsheet divided by their sum instead of their average, which 'likely had the effect of muting volatility by a factor of two and of lowering the VaR'.certain
- JPMorgan paid $920 million in total penalties across US and UK regulators in September 2013, including a $200 million SEC penalty, admitting wrongdoing.certain
Sources
- U.S. Senate Permanent Subcommittee on Investigations, 'JPMorgan Chase Whale Trades: A Case History of Derivatives Risks and Abuses' (report and hearing record, S. Hrg. 113-222), via GovInfo
- JPMorgan Chase & Co. Management Task Force, 'Report Regarding 2012 CIO Losses', 16 January 2013 (via Yale Program on Financial Stability resource library)
- U.S. Securities and Exchange Commission, press release 2013-187 (19 September 2013)
The book
This entry is one of 111 in the register. The full story, and what it cost the people who lived it, is in Risky Business by Claudia Zeisberger, David Munro and Joanna Reijgersberg-Siew.
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