Liability Risk Factor (VRF)
Last updated
Last updated
We then develop an understanding of the protocol’s liabilities.
For v1.0 in particular, we measure the protocol’s capital liability resulting from Taker Claims.
We do this by:
Computing the average floor price weighted by the position size of Takers as a fraction of the current ETH price, and,
Computing the weighted average time to maturity of all Taker positions.
We consider the weighted average time to maturity, the procedure to compute the VRF would assume all Liabilities are "current". This actually may be desirable to some extent such that it may under-damp the protocol’s premium response to the liquidity risk signal, providing agent incentives the necessary time to have effect on the protocol ahead of using secondary measures such as selling assets via keeper trades.
Thus we define two Liability Risk Vectors Each element k of the liability vector v_(k, t) is calculated based on the ratio between some reference (r_(v, k, t)) and its measure (alpha_(v, k, t)). The larger the ratio the higher the risk, e.g., the larger the ratio between the Taker Asset-Weighted Average Floor (TWAF) and the ETH price, the higher is the risk. For standardisation purposes we transform those values such that they are bounded between 1 and 4.
The first ratio:
reflects the relative proximity of the protocol’s weighted average floor price to the currently measured asset price e.g. ETH/USD rate. We use the weighted price floor here to account for the economic risk to the protocol relating to the distribution of Taker floors. For example, a state where the ratio is superior to 1 i.e. the TWAF is significantly greater than the current ETH price, this implies that the average Taker position is deeply in the money. Conversely, if ETH price is higher than the global protocol floor price, the risk of positions being in the money is lower and the ratio is inferior to 1.0.
The second ratio, Taker’s Weighted Average Time-to-Maturity, is a measure of a benchmark relative to the average time to maturity weighted by the position size (based on assets deposited on open, not the remainder after premium is paid).
We use the weighted average term to account for economic risk of the protocol relating to the distribution of Taker positions’ maturities, e.g. a protocol heavily weighted towards shorter maturities is riskier than that skewed with longer maturities.
Then, using the following formulation:
Such that:
