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Bubble Value at Risk: A Countercyclical Risk Management Approach, Revised Edition by Max C. Y. Wong

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Chapter 16

Other Topics

This chapter deals with miscellaneous topics relevant to bubble value at risk (buVaR). First, we discuss the effects of implementing buVaR at the portfolio level. Are diversification, aggregation, and decomposition similar to that of conventional value at risk (VaR)? Is basis risk well captured? Second, we look at how buVaR as a new framework for measuring risk is able to meet the ideals proposed by the Turner Review. Lastly, we reflect that buVaR can be seen as a potential new direction in the quest to create a good riskometer.

16.1 DIVERSIFICATION AND BASIS RISKS

A risk measure is of limited use if it cannot be aggregated in a diversifiable way. BuVaR preserves the correlation structure even after incorporating countercyclicality, which means that the benefits of diversification are maintained. Profit and loss (PL) vectors of different positions, portfolios, and even of different banks can be aggregated. The reverse process of decomposition is best achieved using the method of incremental VaR of Section 6.3.

Recently there has been a lot of pressure from regulators for banks to include and improve on the measurement of basis risk, which is seen as under-represented in current VaR systems. Basis risk arises from long-short and spread positions. Since such positions are intended to be market-neutral (not sensitive to general market movement), one can expect the basis to be not volatile almost all the time except for exceptional days when there is idiosyncratic ...

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