And Here Is Why VaR And Liquidity Risk Are Kinda A Big Deal

One of the least understood concepts on Wall Street - Value At Risk aka VaR. For a good practical example of what happens when it goes ballistic, see the Goldman Press Release. And for some observations on why VaR could be the latest black swan-in-waiting, as well as for a much more in depth overview of liquidity, especially as it pertains to lack of diversity, please read the attached presentation out of the Professional Risk Managers' International Association.

Liquidity black holes, such as the ones we see growing all around us these days, imply that the VaR methodology of "risk evaluation" is likely the next major risk factor for the capital markets. Trust Goldman to leads the charge in seeing how much they can get away with before another market "event."

Also, some good introductory material for all those who have been consistently inquiring about more information on market liquidity and the lack thereof.

hat tip Richard

Comments

[Anonymous]

OK, so the presentation's pdf is nothing but questions. I assume the answers were forthcoming in the presentation itself. What did they opine about China, or the other black swans they asked rhetorically?

[Anonymous]

VAR doesn't matter when all your trades are winners. It's good to be Goldman Sachs!

[Anonymous]

For those who aren't already familiar with the severe limitations and mis-use/abuse of VaR as a "risk management" tool, check this out http://en.wikipedia.org/wiki/Value_at_risk#Criticism

[Anal_yst]

Whoops last post was from me, forgot to login

[Anonymous]

While there are a lot of critisism of VaR it may be worth noting that the above presentation seems to have been made in 2005, well before anyone had picked up on the issues in the current crisis.

This could lead to the conclusion that:

Risk managers where in general well aware of the potential problems that eventually emerged, and also aware of some of the risk of relying on VaR.

But apparently the people in charge did not take heed.

This does not seem to be a math, quantitative risk measurement or statistical model problem but an anthropogenic one: Greed and stupidity

[Anal_yst]

I'd say you're at least close to hitting the nail on the head.  VaR, like any other tool, has its uses, however, in the wrong hands, its potentially lethal.  Sure, our VaR at 95% is $250m, unfortunately we could blow it out $3bn in a day if sh*t hits the fan, but its not "very likely" to happen so we'll take our chances...

[Anonymous]

ANYONE FROM RBS THAT IS LECTURING ANYONE ON VaR EITHER HAS A GREAT SENSE OF HUMOUR OR IS COMPLETELY F***ING DELUDED !!!!!!!!

[ng2amarinefunk (not verified)]

well, yes, VAR calculation is, actually, so transparently false a "financial fiction" that one is tempted to consider, in the light of "events" of this past year, it pure opportunism by the financial institutions towards overly profitable transactions, using Other People's Money.

It had been well known, as pointed out by Mandelbrot, in the real world of Engineering - of water dams specifically - that the 'risk' of overfill does not follow, simply from simple adumbration of all the relevant dimensions into a simple aggregation of the totality rainfall, pull down, and a few other factors - into a kind of 'Law of Large Numbers"bell curve, with sigma 1, 2, 3, 4, 5, so forth

No, the dimensions involved play-out "over time"  that dimensionality must be considered and NOT aggregated at all - that is the magical trick VAR is INTENDED TO HIDE
for, it is, as unfolded in time, that the water dam fills and drains in a non-gaussian non-bell curve manner, not as a simple square root of the sum of the squares sort of thing.  The Hurst formula ...." from the Nile to the Market Place"  per Mandelbrot applies has always applied metaphorically speaking, to ALL financial risk profiling

You see, that reducing star-sightings, a two dimensional statistical analysis, static in human time, and irrelevant in the third dimension of 'depth' 'distance change' for the purpose....it THAT yes, the power law of 2 applies quite simply, as the power law of 3 in a volumetric

But when, TIME is involved, the 4th dimensional, THEN the instant of "sight-reduction" call it, cannot be reduced  for statistical prediction...neither the price of rice in China, nor the peaking waters of the Aswan High Dam

Hence, the use of fractal dimensionality, has SOME application in Finance, but the two dimensional analytics of VAR has none, a pure fiction devised to screw the majority into cheerfully giving, giving, and more..