Bubble Value at Risk: A Countercyclical Risk Management Approach, Revised Edition

Chapter 17

Epilogue: Suggestions for Future Research

This book hopes to pave the way for a new approach in measuring risks, one that is unrestrained by ingrained notions of being independent and identically distributed (i.i.d.), stationarity, and normality of financial variables. Without such assumptions, mathematical risk models will lose a degree of tractability but will gain a practical ability to handle the risk of fat tails and procyclicality. Essentially, we have lost precision but have gained accuracy, and hence become less “wrong” in our assessment of risks.

The removal of these strict mathematical conditions leads to an open arena for further development of the basic bubble value at risk (buVaR) framework beyond what is described in this book. Some potential directions for further research include:

1. Calibration: Determining a more elegant theoretical upper limit for buVaR calibration. In this book, we used an average of the largest daily changes encountered in all history capped by a possible circuit-breaker (cap on day loss) imposed by the exchange. The weakness is that some markets do not have circuit-breakers (such as commodities and FX markets) and nascent markets will not have enough history of downturns for proper calibration. Ideally, the upper limit should be based on some natural limit imposed by the financial system environment. Such a limit should be intuitively justified and should not come from mathematical abstractions.

2. Benchmarking: The computation ...