Chalengr
09-02-2009, 12:31 AM
Hi AO,
this is my first post here! I just want to get some of your thoughts. I was reading a speech by David Einhorn, a hedge fund manager, and he mentions something interesting:
The second question is how do the investment banks justify such thin capitalization ratios? And the answer is, in part, by relying on flawed risk models, most notably Value-at-Risk or “VaR.” Value-at-Risk is an interesting concept. The idea is to tell how much a portfolio stands to make or lose 95% of the days or 99% of the days or what have you. Of course, if you are a risk manager, you should not be particularly concerned how much is at risk 95 or 99% of the time. You don’t need to have a lot of advanced math to know that the answer will always be a manageable amount that will not jeopardize the bank. A risk manager’s job is to worry about whether the bank is putting itself at risk in the unusual times or in statistical terms, in the tails of distribution. Yet, Value-at-Risk ignores what happens in the tails. It specifically cuts them off. A 99% Value-at-Risk calculation does not evaluate what happens in the last one percent. This, in my view, makes VaR relatively useless as a risk management tool and potentially catastrophic when its use creates a false sense of security among senior managers and watchdogs. This is like an air bag that works all the time, except when you have a car accident.
Do you agree?
this is my first post here! I just want to get some of your thoughts. I was reading a speech by David Einhorn, a hedge fund manager, and he mentions something interesting:
The second question is how do the investment banks justify such thin capitalization ratios? And the answer is, in part, by relying on flawed risk models, most notably Value-at-Risk or “VaR.” Value-at-Risk is an interesting concept. The idea is to tell how much a portfolio stands to make or lose 95% of the days or 99% of the days or what have you. Of course, if you are a risk manager, you should not be particularly concerned how much is at risk 95 or 99% of the time. You don’t need to have a lot of advanced math to know that the answer will always be a manageable amount that will not jeopardize the bank. A risk manager’s job is to worry about whether the bank is putting itself at risk in the unusual times or in statistical terms, in the tails of distribution. Yet, Value-at-Risk ignores what happens in the tails. It specifically cuts them off. A 99% Value-at-Risk calculation does not evaluate what happens in the last one percent. This, in my view, makes VaR relatively useless as a risk management tool and potentially catastrophic when its use creates a false sense of security among senior managers and watchdogs. This is like an air bag that works all the time, except when you have a car accident.
Do you agree?