VAR Trend is Your Friend (or at least a good early indicator)

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

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.

Computerless Risk

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

 

I was teaching a course in the Bahamas recently when the power went out.  It does not happen that often, but it happens.  In fact the power is more likely to go out when I am at home in Halifax – thanks you Mr. Winter Storm. 

The issue with the power is that I was giving a lecture on model building in Excel.  How do you teach computer model building if there is no power for your computer (and the battery is dead in your laptop and the overhead projector will not project)?  And yes, for those of you who are curious, we had already covered the theory. 

It got me to thinking – how well would your risk management system work without computers?  How well would you be able to model your risk exposures?  More importantly, how would you understand the trends in your risk exposure? 

Now to go to the next level of questions, how well do the people in your organization understand the risk model data that your system currently spits out?  Do they know it well enough to “game it”?  Do they know it well enough to know where its weak points are?  Do they know it well enough to know when it will provide non-intuitive or incorrect results?  Do people in your organization still have intuition about risk exposures – or is it all computer driven? 

I fully understand that your organization likely has redundant systems, and so an isolated computer glitch will not change things.  But why not also have redundant people systems – that is people who can back up the computer if the computer is down or producing irrational results?  Why simply not have the best computer of all working for your risk department – the human brain? 

By the way – our class went on quite well even without power.  Amazing thing the human brain.  No power cord!