JPM Fixed Income revenue

Looking through the JPM earnings release today, I noticed their Fixed Income revenue for Q1 2010 was $5.4 billion, higher than their Fixed Income performance in any quarter last year. However, their Fixed Income VAR has dropped dramatically. Their best performing quarter last year was Q3 with $5 billion revenue and VAR of 182, however their Q1 2010 Fixed Income VAR was only 69.

How was it possible for them to make so much money while reducing risk by such a significant amount?

Interested to hear from some of the traders out there.

 
Best Response

I think VAR is a statistical measure based on volatility; your expected returns on the 2nd worst day out of 1000 assuming a normal distribution of returns. In other words, if your volatility goes down massively (it's pretty low right now relative even to 2009 Q3 and definitely 2009 Q1), your VAR goes down, too.

VAR is a decent measure of short-term risk but not quite the same measure of longer-term fundamental risk. If JPM has breakdowns on what they own, I'd recommend comparing asset classes (high yield vs. high grade debt) and how much they own, net-net, of each. I'm willing to bet the numbers will be higher than in Q3.

Disclaimer: Trading strategies guy and former analytics guy. Not a trader.

 

I know what VAR means. Volatility leads to wider bid-ask spreads and hence why trading revenue is somewhat correlated to it. With reduced volatility and contracting bid-ask spreads, my question is how were they able to perform so well in Fixed Income? Unless more of it comes from prop trading, I don't see how it would be possible. It's not like the yield curve has gotten any steeper either. I'm sure there's a simple answer ...

As for breaking Fixed Income down into high-yield vs Investment grade, I don't see how that would help answer the question. Both products purely take on duration risk afaik.

 
Brown_Bateman:
I know what VAR means. Volatility leads to wider bid-ask spreads and hence why trading revenue is somewhat correlated to it. With reduced volatility and contracting bid-ask spreads, my question is how were they able to perform so well in Fixed Income? Unless more of it comes from prop trading, I don't see how it would be possible. It's not like the yield curve has gotten any steeper either. I'm sure there's a simple answer ...

As for breaking Fixed Income down into high-yield vs Investment grade, I don't see how that would help answer the question. Both products purely take on duration risk afaik.

A lot of analysis is typically done on both credit risk and rates risk by risk management- and most firms have that data and the capability of doing a position-by-position analysis on Credit01, IR01, RAC, etc. I would imagine that both Credit01 and IR01 or one of their derivatives would factor into calculating VAR, though I've never worked in risk management. Most fixed income products carry credit and rates risk, so I think a good risk measure is probably going to factor in both.

As for the vol vs. income, I'm not a trader, but most of us studied econ. If there's a sudden catastrophic event that reduces the number of suppliers (in this case, of liquidity), and that catastrophic event abates, do suppliers come back immediately, or do they take time to come back?

Put another way, let's say that the federal government mandates the bulldozing of all coal-based power plants. Six months later, it lifts the ban. Do electricity prices fall immediately or does it take a while for new businesses to form and new power plants to spring up? Bear in mind that there are significant barriers to entry for a fixed income client trading franchise; they don't just spring up overnight.

If I weren't already heavily exposed to the capital markets, I'd be snapping up broker/dealers and financial intermediaries like crazy right now. This will be probably be a very good economic cycle for the survivors- I'm just not sure how long the cycle will last while we're only a little over halfway through a secular bear market.

 
IlliniProgrammer:
As for the vol vs. income, I'm not a trader, but most of us studied econ. If there's a sudden catastrophic event that reduces the number of suppliers (in this case, of liquidity), and that catastrophic event abates, do suppliers come back immediately, or do they take time to come back?
Don't see how that explains how they made more profit this year. Unless I misunderstood you, surely, that would lead to less profit in Fixed Income? i.e. 2009, suppliers down (Lehman, Bear etc), other banks not willing to take risk on (UBS, MS) hence prime time to make profit from widening spreads while gaining market share, but in Q1 2010, both MS and UBS et al were active once again in Fixed Income and bid-ask spreads were reduced, so wouldn't that mean JPM makes less as they lose some of that market share they picked up easily in 2009?
 

Well, they group Currencies and Commods under Fixed Income when reporting revenue, but the VAR figures are broken down further.

If you look at page 11 of this though http://files.shareholder.com/downloads/ONE/891891724x0x365100/6bc0ae53-…

you'll notice that FX and Commodities VAR didn't change much in Q1, but Fixed Income VAR was reduced significantly.

If you look at the Fixed Income VAR for 2009 and compare it to revenue on page 9, you'll see the correlation between the VAR and the revenue generated in Fixed Income for the four quarters last year, but that correlation seems to have been broken completely in Q1 2010.

 

Bid-offer spreads HAVE narrowed - massively. Look at swap bid/asks; gone from something like 4-5bps post Lehman to sub-1bps (pre-crisis levels). Credit bid/asks have come in massively also. I think the biggest reason is what post #1 referred to. LEH bankruptcy just jumped out of the 500 day VaR models, most widely used industry wide I believe. Could also be down to greater prop positioning but I'd question the extent to which this has led to such epic revenues being posted.

 
Megashite Trader:
Bid-offer spreads HAVE narrowed - massively. Look at swap bid/asks; gone from something like 4-5bps post Lehman to sub-1bps (pre-crisis levels). Credit bid/asks have come in massively also. I think the biggest reason is what post #1 referred to. LEH bankruptcy just jumped out of the 500 day VaR models, most widely used industry wide I believe. Could also be down to greater prop positioning but I'd question the extent to which this has led to such epic revenues being posted.
I briefly remember hearing the bid-ask spreads were pretty crazy when the world was ending in Sept. and Oct 2008, but can you comment on bid/ask spreads from Q3 2009?
 

Did you expect a top 4 US bank, to not report amazing FI earnings when the Fed is loaning them money at 0.0%.

Find an Exonn or HF (with exceptional credit), loan them 500mm over 6 months at 2.2%, borrow from fed at 0.0%. Repeat 5 times, Bam money market trader is done for the year he can go sleep. Ofcourse its not that simple, but its also not super difficult.

 

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