levinsontodd

Comparing Value-at-Risk to Crash-and-Burn

VAR is not the problem. The problem is that people don't understand it is a model.

While VAR can approximate risk, given the normal fluctuations of the market, based on past market behavior, it can't approximate for the bad, and some might argue fraudulent investing decisions that are at the heart of this financial crisis. That's because no economic or mathematical model can predict human behavior.

If you think because your portfolio meets some arbitrary level of VAR that means you are fine, then you are in trouble. If you realize it is one piece of data that can help you understand the whole picture, then you are using your brain.

It worked for a long time, because it did exactly what it claims to do: measure the value at risk in your portfolio given normal market conditions.