How has the financial crisis changed our attitudes to value at risk?
For many risk managers, the unrelenting financial meltdown
has left them questioning the very essence of risk modelling.
While investment firms have traditionally relied on
fantastically complex mathematical models for measuring the
associated risk in their various portfolios, the events of the
past three years has left the reputation of risk modelling in
tatters. With this in mind risk management, and in particular
Value at Risk (VaR), now needs to evolve to enable more
accurate calculations and foresight.
In short VaR allows banks and investment firms to make quick
and simple predictions on the potential losses of trading.
While its use is undeniably invaluable, its ability to estimate
tail risk has been criticised following the worldwide financial
crisis. Although its application has been extended in many ways
to reflect liquidity risk and take into account operational
risk and basic stop losses, it is still backward looking and
can fall short if there is an extreme change in price.
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