by Rick Nason PhD, CFA
Partner RSD Solutions Inc
There has been a whole lot of writing lately about how Value at Risk (VAR) is a fraud as a risk measure. Not quite sure what all of these writers are complaining about so I thought I would try out some of their reasoning. To do so I tried to make a latte with my car. You know what – the people who claim that VAR is a fraud are right – I could not make a latte with my car – although it is what I consider to be quite a nice car.
After reading that paragraph you are probably thinking that I have gone loco. Of course I cannot make a latte with my car. My car (any car) is for driving, not for making lattes. Even a child knows that. However those who argue that VAR is a fraud because it did not allow financial institutions to see the crisis coming are missing the point – just as I am missing the point thinking that my car could make a latte.
VAR and other risk measures and tools are actually quite good at what they are designed for. VAR however is not a prediction tool for a crisis, and VAR is not a great tool for assessing systematic risk.
All too often in risk – as in other fields – we have a temptation to use whatever tools we have for whatever purpose. It is just like the old saying that “to the inexperienced builder holding a hammer that everything looks like a nail.” Just because you have a specific tool or metric that some smart people developed, does not mean it is appropriate in all cases and for all situations. That is simply common sense.
Meanwhile I have to go get into my car so I can go get a latte at Starbuckys.
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