VaR – a fantastically complex mathematical model for measuring the risk in various portfolios - has received some bad press of late. Many have argued that the recent financial crisis was ultimately a crisis of modern metrics-based risk management, and VaR
is a major culprit.
While undoubtedly risk modelling, as we know it, needs to evolve to better cope with market risk, arguably it is more banks’ and traders’ approach to, and use of VaR, that needs to change, rather than the actual model itself.
It’s now clear that VaR must be viewed as an operational, rather than a reporting, metric. This means instead of relying on a single number, traders need to look beyond the top line, delve into the complex mathematical calculations and gain a better understanding
of the type of risk they’re taking and how it can best be mitigated.
When used simply as a reporting tool, receiving VaR calculations within 24 or 48 hours is adequate. However, if traders are to have the ability to act on the information provided within the VaR calculation, they require the information much more quickly. While,
real-time VaR might not be necessary, within the trading day is crucial.
If we can learn from the market turmoil of the past 18 months and evolve risk modelling in line with these lessons, surely the widespread institutional reliance on VaR will redeem its reputation and prove itself as an effective way of managing market risk?