by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
For some reasons a lot of stuff has come across my desk recently that is bashing Value at Risk (VAR) and saying that it is a symbol for all that is bad in risk modeling. I think it is time for a time-out. As risk specialists, we also have to be optimists and look for the good in everything.
One thing that I think that VAR is good at is indicating change. I too recognize the limitations of VAR. (One of the reasons so much is crossing my desk is that I teach several different courses in financial risk and also in Enterprise Risk Management.) The limitations have been well documented.
What is less well recognized is that VAR is still a very useful tool. One of the ways to use VAR that helps to maximize its usefulness while minimize its weaknesses is to follow the trend of how the company (or project) VAR is tracking. Looking at the trend, rather than the absolute number, can help you to ascertain when a shift in risk exposure has occurred. It will also help to base-line out the traditional faults such as the use of parametric statistics or the use of the incorrect distribution.
Tracking the trend of VAR is not a perfect remedy. Watching the trend of a bad and inaccurate model, will still give useless and potentially misleading results. However if a decent VAR model is constructed, and if more attention is paid to the trend than the absolute VAR number, then more useful (and accurate) information will be generated.
1 comment:
Good evening,
I have read your article about VAR modeling and trend. This moment I am analyzing Lithuanian (my native country) and other countries prices using VAR model. I have confronted with such problem. I would like to ask how to deal with this problem, because when I add trend in VAR model the model errors still remains nor normal.
Thank you very much for information and help.
Post a Comment