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

Foreword

Financial markets are all about risk management. Banking and capital markets activities throw up all manner of risk exposures as a matter of course, and these need to be managed accordingly such that stakeholders are comfortable. “Market risk” traditionally referred to risks arising from a change in market factors, and when we say “risk” we mean risk to the profit and loss account or to revenues. These market factors might be interest rates, foreign currency rates, customer default rates, and so on. Managers of a financial institution should expect to have some idea of the extent of their risk to these dynamic factors at any one time, so that they can undertake management action to mitigate or minimize the risk exposure. This is Finance 101 and is as old as commerce and money itself.

Measuring market exposure has always been a combination of certain methods that might be called scientific and others that might be described as application of learned judgment. I have always been a fan of “modified duration” for interest rate risk and I still recommend it. Of course it has its flaws, which estimation method doesn’t? But when Value-at-Risk (VaR) was first presented to the world it appeared to promise to make the risk manager’s job easier, because it seemed to offer a more accurate estimate of risk exposure at any time. And the latter was all it ever was, or claimed to be: an estimation of risk exposure. A measure of risk, no better and no worse than the competence of the person ...