Continue some thinkings about VaR

2008-09-16

Continue some thinkings about VaR

Considering the current situation of Lehman, I have to think about VaR much deeper. As we know, a deep drawback of VaR is assuming the normal condition. We hardly can predict the extreme situation from our normal assumption. For two popular approaches of VaR, parametric VaR is using long horizontal data to compute the correlation and volatility matrix, which may have lots of bais, such as distribution assumption, data noise etc; historical VaR is using, maybe shorter time horizontal, to assume the return rate change. We know both pros and cons of those two approaches, but we should more seriously considerate that it does not matter which approach you are using or even both, VaR still can not predict the extreme situation which is most concern by the seinior management team.

While, it is true that VaR has huge limitation, but VaR at least can figure out the problem of Mr.Lesson hedging strategy risk. While, just not Lehman one, I guess …

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Tags: finance, risk, VaR
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