4.2.Culp, Miller, & Neves

  1. Advantages of VaR
    • Consistent: easy to use across diff LOB & products
    • Probability based: can specify confidence level
    • Common time horizon
  2. Calculation of VaR
    • 2-step process: (1) generate prob dist for price or return of each security, and (2) aggregate the individual distributions using an appropriate assumption about their correlation
    • Usually assumes PF composition doesn't change, which is fine as long as time horizon does not exceed 5 days
  3. Uses of VaR
    • Risk reporting
    • Risk control
    • Risk mgmt
    • Capital allocation
    • Exposure monitoring
  4. 4 derivatives disasters
    • Proctor & Gamble: fixed-for-floating interest rate swap w/ spread heavily reliant on no rate incr. VaR was of no help since not intended for transactions
    • Barings: bet on japanses stock mkt. Mgmgt wouldn't have been able to monitor VaR as the trader was responsible for recording his own trades
    • Orange County: VaR wouldn't have make a change if potential updside was considered too
    • Metallgesellschaft: sold fixed-price oil contracts and hedged risk using short term future contracts. They had full knowledge of risk (were using selective hedging)
  5. Alternatives to VaR
    • Cash Flow risk: simulation
    • Risk based capital: evaluate opportunities
    • Shortfall risks: focus on shortfall relative to some doomsday level
Card Set
4.2.Culp, Miller, & Neves
Culp, Miller, & Neves