Pablo Triana On Risk Management

Pablo Triana has an excellent and understandable article in Business Week on why we need to quit obsessing about Value at Risk measurements at the banks:

So what should we read from Goldman’s currently high VaR figures? Not much. VaR naturally increases following a period of broad unrest, because the model’s inputs reflect more of that turbulence and less of the prior tranquility. So a pumped-up VaR doesn’t automatically point to wild-eyed gambling. The opposite could even be true—Goldman could be trying to trim risk while its VaR rises.

What should replace VaR? We should reintroduce the spirit behind the way we calculated risk before VaR took over on trading floors and in the offices of regulators in the early 1990s. That means using intuition and experience-honed common sense. It means accepting the principle that toxic assets should be considered riskier than liquid assets—and that fancy math and past performance can be deceiving predictors that often deliver a lethal dose of leverage. We need rules and risk committees that limit a bank’s “bad” leverage by requiring much more capital to cushion, say, a subprime collateralized debt obligation than to offset Treasuries. It’s time to give up analytics so that real risk can be revealed.

There is a lot more to the article. He points out the historically bad performance of VaR during the recent crisis and suggests that the fixation on VaR among certain parts of the press is useless.

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