Snappy Comeback to the Latest Criticism of VaR

Last week, the Swiss pulled their peg, and swissie soared. Part of the fallout—surprise, surprise!—is criticisms of value-at-risk. This time The Economist is leading the charge, writing: … Another likely casualty is the ‘value-at-risk’ models banks use to calculate the maximum they might lose on any given investment or transaction. But banks’ value-at-risk models don’t measure the “maximum they might lose”. They measure the maximum … Continue reading Snappy Comeback to the Latest Criticism of VaR

A Revelation

I have written about it before, and I am sure I will write about it again. … how financial risks that devastate firms aren’t random occurrences, as if the gods on Olympus toss dice to determine a company’s fate. No. There are causes. And these are usually traceable to human frailties. Most often, the specific human frailty is hubris. Think Orange County, Enron, Bernie Madoff … Continue reading A Revelation

What’s Your Risk Appetite?

Suppose you arrive at your dentist’s office for an appointment. Before escorting you to an examination room, the receptionist asks what your pain appetite is. That afternoon, you head over to the Apple store to buy the latest iPhone. A sales clerk at the front door points you to the line stretching around the block and asks what your wait-time appetite is. That evening, you … Continue reading What’s Your Risk Appetite?

Is Risk Management a Job or a Career?

There are few life decisions as consequential as your choice of career. Get it wrong, and you’re in for a world of discontent. Perhaps you currently have a risk management position and are wondering if you can make it a career. Or maybe you are just starting out and are contemplating risk management as a career. First ask yourself this. “Is risk management even a … Continue reading Is Risk Management a Job or a Career?

How to Calculate Value-at-Risk – Step by Step

The power of value-at-risk lies in its generality. Unlike market risk metrics such as the Greeks, duration, convexity or beta, which are applicable to only certain asset categories or certain sources of market risk, value-at-risk is general. It is based on the probability distribution for a portfolio’s market value. All liquid assets have uncertain market values, which can be characterized with probability distributions. All sources … Continue reading How to Calculate Value-at-Risk – Step by Step

Fooled By Black Swans

Imagine you are presenting to the board about risk management. The presentation is going well, and you are about to finish up when a board member stirs. He hasn’t said a word the entire meeting, so this is his chance to look smart. He asks “What are you guys doing about black swan risk?” What a way to ruin your day! The concept of black … Continue reading Fooled By Black Swans

List Of Risk Management Failures

Those who cannot remember the past are condemned to repeat it. Nowhere is George Santayana’s famous admonition more applicable than in the field of risk management. As a reminder of all the ways things can go wrong, I maintain an informal list of prominent risk management failures. I just updated the list and thought I would share it with you. My list includes mishaps since … Continue reading List Of Risk Management Failures

What The 4 T’s Overlook

If you have been active in risk management for a while, you have probably heard of the 4 T ‘s. These—at a very high level—are the four possible responses to risk. Conveniently, each begins with the letter T: Tolerate Treat Transfer Terminate They appear in various risk management standards. They pop up in books, articles and web searches. Would you believe they are incomplete? They … Continue reading What The 4 T’s Overlook

Nickels In Front of Bulldozers

There is an old saying on trading floors: Watch the trader who makes consistent money. He is the one who is going to blow up. In his book When Genius Failed, on the 1998 failure of hedge fund Long-Term Capital Management (LTCM), Roger Lowenstein shares a compelling analogy for this: Picking up nickels in front of bulldozers. LTCM made consistent money for a number of … Continue reading Nickels In Front of Bulldozers

Upside Risk, Downside Risk

Risk has two components: exposure, and uncertainty. If either is absent, there is no risk. But some people insist there must be a third component: downside. Let me explain. If you are uncertain about some consequential event, the set of possible desirable outcomes is sometimes called your “upside risk”. The set of possible adverse outcomes is then your “downside risk”. For example, if you will either … Continue reading Upside Risk, Downside Risk

Conflict Over Risk Management: A Case Study

Conflict is a recurring problem for financial risk management. At your own firm, are risk managers dismissed as “risk police”? Are risk committee meetings contentious? Do traders hoard information? If you answered “yes” to some of these, you may have a serious problem. I just returned from London where I conducted a two-day strategic planning retreat for a client. They are a private wholesale firm … Continue reading Conflict Over Risk Management: A Case Study