Suna Reyent

Defending VAR - But You Still Need Common Sense

Mr. Heath - thank you for eloquently explaining the Goldman episode in the framework of testing a hypothesis.

morph366 - I'm not saying that the quants are misunderstood. I'm saying a lot more than that.

I'm saying that the quants, or more specifically quantitative models, are used as whipping boys in what turns out to be a great lapse in plain old business ethics. It is not the self-serving "quant" rhetoric that I am concerned with, but very much the other way around.

It is rather the self-serving justifications of the failed Wall Street management that concerns me. Titanic was sinking, and its captains skillfully escaped the ship first, while pocketing large bonuses and leaving the rest of the passengers (the American taxpayers) on board. What was the music played by the orchestra? The now famous our-VAR-models-didn't-... tune.

I must admit that the massive PR campaign that so successfully packaged the blame onto quantitative models, as well as the sensationalism offered by Taleb make all of this a lot easier to swallow.

This is not a "protest" piece as it is a piece that aims to give a background on value at risk and hopefully show people how to think about it. I for one use the concept (loosely) in my simple stock portfolio allocation to have an idea on what I can expect to lose, 95% of the time, 99% of the time, or 99.9% of the time. You would be surprised at how well it does, especially if you adjust your variables or data depending on how markets change. Of course, that's also a form of ART as much as investing is.

As I've tried to portray, VAR works a lot better (and is much easier compute) for simple portfolios that take no derivatives positions (especially with assymetric payoffs) or leverage. No, VAR will not save the world. Yes it can be wrong depending on how markets change. Yes you can come up with different values of VAR depending on your assumptions about markets. Yes it requires a human being to interpret the number. And NO it is not acceptable to blame VAR for your losses when things turn sour.