Good news for AD?

Maybe I did not lose as much as I though in Sometimes you win, sometimes you lose. Maybe Algorithmic Differentiation (AD) is not forbidden by regulators as much as I feared.

A couple of months ago I attended and spoke at the 5th xVA conference. I was also part of the panel discussion on “GPU vs AAD” debate. Among the questions opened for the debate was "Can AD be used for regulatory/FRTB purposes?"

I explained the reason behind that question in my previous blog and in my comments to the consultative document by the BCBS. My comments can be found, among other comments, on the site of the Bank for International Settlements. The regulatory documents give a precise (but incorrect in my opinion) description of the meaning of sensitivity. The sensitivity for interest rate is the forward differentiation quotient computed with exactly a one basis point shift.

The good news, if confirmed, is that the previous bad news may not be true. A staff member from the Federal Reserve Board, which has been involved in the discussion around FRTB, indicated that the wording should not be understood has preventing AD. The "definition" is supposed to be a general description of what sensitivity should be and its scale, not the numerical procedure. In some sense the letter of the law is not the letter of the law anymore.

It is still questionable that the text, which is precise in its wording, does not mean exactly what it says. Also it is not a first draft imprecision, it is a much commented text for which this precise question was asked publicly and officially, including by me in my comments published on the web page relate to the issue by BCBS. A simple and clear alternative wording was proposed.

This was a simple one line change with respect to the wording used in the draft. Why was this not clarify? Did the BCBS read all the comments? Are the drafting staff and the staff reading the comments collectively well versed and experienced in all the quantitative finance and numerical analysis aspects described in the rules and its comments? I don't know the answer to those questions, I can only guest from the final outcome. This document will impact the management of trillions and trillions of balance sheets in the world, you could expect a document quality in line with was is expected as documentation for model validation purposes in a tier 3 bank in relation to models used for notional of a couple of millions in derivatives.

At this stage, I hope that the remark by the Fed staff member will be clarified officially by the BCBS or local regulators. This should come at least as an official interpretation of the document and preferably as a footnote in the original document.

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