Timing of testing

The purpose of price testing is to validate the valuation of positions and risks at a
specific point in time. The challenge is to perform the price testing function frequently
enough to provide reasonable assurance that positions are materially marked. The
price testing priority is clearly the trading book, rather than the banking book, as it
is required to be marked to market.
A generalized best practice that seems to be developing for market-making institutions
is to price test the trading books at least twice a month. The benefits and
expense of performing this function needs to be balanced with the risks and nature
of the positions.
Ω Once at month end to validate the financial statements.
Ω The second price testing is usually performed on a variable date basis some time
in the middle of the month. It provides an added control function as the traders
cannot predict the date of testing. The mid-month test also defines that the
maximum length of the misstatement of financial statements and risks that can
occur to about two weeks before being picked up. One of the nice attributes of the
variable second price testing is that it provides the manager of this control process
with flexibility to schedule it as best suits the workload of the team (i.e. projects,
system implementations, vacation schedules).
It is important to understand who are the users of the PnL and position information
within the firm. The users of the information are beyond financial reporting. As can
be seen in Figure 19.2, the users cover regulatory reporting, risk management, front
office and the senior management who are required to understand both the PnL and
risks of a firm on a daily basis. Much of the downstream processing (i.e. PnL and
risk valuations) is dependent upon the accuracy of the priced positions. The timing
of the tests and delivery of the reported results should be designed with consideration
of the downstream users and routine meetings where the information will be a
discussion topic.