VaR-iations in your risk management
David Millar, risk consultant, trainer and former COO at PRMIA, looks at the value at risk problems at JPMorgans’s chief investment office and wonders if these are hiding other poor practices. May 31, 2012 | David MillarFollowing the 1987 stock market crash and fed up with never knowing what his losses would be, the late Sir Dennis Weatherstone, then chairman of JPMorgan, asked his senior management “How much can we lose on our trading portfolio by tomorrow’s close of business?” This was to be on his desk by 4.30pm each day (the Four Thirty Report). Out of this simple request was born the concept of value-at-risk (VaR), an estimation of the maximum that a portfolio can lose in a fixed period to a predefined level of confidence. JPMorgan spent some years perfecting this measurement system and in 1992 made it available to the world as the Riskmetrics methodology, later spinning this off as a separate company. Whether we like it or not, VaR has now become the essential tool of all risk management and risk regulation. Alternatives have been proposed – cash-flow volatility, abnormal returns, and deviation from a shortfall position. All have their proponents and are used in certain area such as pension and insurance funds. Indeed cash-flows may be the answer to measuring liquidity risk, something that VaR has problems with. However, none of these has succeeded in toppling VaR from its pillar of acceptance, a position driven partly by the adoption of VaR by the regulators. Today, a daily VaR figure is insisted on by the regulators in most of the major financial centres and, if you want to calculate risk-based capital according to the more detailed approaches, there is no alternative to using VaR. Basel has set VaR in stone and given it its final seal of respectability (as it did for credit rating agency scores – but that is another story). However VaR is only a tool, one of many in the management of risk. I am sure that Weatherstone used it as a warning signal, a key risk indicator, but that he did not base his sole strategy on this single number per portfolio, something that Dick Fuld is reputed to have done at Lehman Brothers. The problem is that... Please login to read the complete article. If you already have an account, you can login now or subscribe/register.
Categories: Capital & Strategic Issues, Regulation, Risk and RegulationCapital & Strategic Issues,riskregulation,Risk and Regulation, Capital & Strategic Issues,Regulation,Risk and Regulation, Keywords:VaR, Hedging, Risk Reporting, Riskmetrics Methodology, Sir Dennis Weatherstone, David Viniar, Asymmetric Risk Instruments, CDS, Market Risk VaR, Hedging, Risk Reporting, Riskmetrics Methodology, Sir Dennis Weatherstone, David Viniar, Asymmetric Risk Instruments, CDS, Market Risk
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