Term
| (3) useful features of VaR |
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Definition
1)Consistent- Expressing the risk in dollar terms made it easy to use across different lines and products
2)Probability based - Management can specify the confidence level and use VaR as forward looking
3)Common Time Horizon |
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Term
| Main Points about VaR calculation |
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Definition
1)1st generate probability distribution for the price of each security, then aggregate individual distributions using correlation assumptions.
2)Traditional VaR assume the portfolio composition does not change over the time horizon. |
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Term
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Definition
1)Risk Reporting - quick and easy to management
2)Risk Control - Means to monitor and set risk levels by market/trading group/counterparty
3)Risk Management - VaR provided useful hedging information on an individual transaction
4)Capital allocation - can measure risk adjusted returns for compensation or capital allocation purposes
5) Exposure monitoring - non-trading firms tend to use to monitor eternal fund managers or assessing colateral requirements. |
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Term
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Definition
| P&G got lower fixed rate in return for a variable rate that was based on the difference between yield of 5 yr and price of 30 yr bond. Lost over 100 M dollars when yield increased. P&G likely didn't understand the risk they look on. |
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Term
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Definition
| -individual trader lost 1 B in bets on Japanese stock market. He was responsbile for entering his own positions. No one was montinoring the exposure. If IT system and montioring with VaR was inplace, would have prevented it. |
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Term
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Definition
| Lost 1.5 B betting on the slope of the yield curve. VaR would not have been that helpful because it would only have shown the downside, not the potential upside returns. |
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Term
| Metallgesellschaft (MGRM) |
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Definition
| sold long term fixed price oil contracts and hedged the risk with short term futures. When prices moved they suffered large paper losses, forcible liquidated by senior management. Risk was understood, so VaR would have been helpful. Real problem was cashflow. |
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Term
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Definition
1)Cashflow risk : Simulation of future cash requirements
2)Risk Based Capital : can be used to take into account losses AND potential gains. What is the cost of capital?
3)Shortfall Risk: focus on shortfall vs some doomsdaylevel instead of confidence level |
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