What many people forget to focus on is the fact that what happens the other 1-5% of the time is what counts.
What many people don't know is that there are 3 types of VaR. The Risk manager presenting the report usually just mentions the number and that is all, but scratch below the surface and you can learn what your risk manager is really thinking. Next time ask them what type of VaR they are using and keep this handy explanatory list nearby to decipher what they are saying.
2. "We use our mighty computer resources to calculate a Monte Carlo simulation for VaR." (I take history, blow it into a million little pieces and then each piece will bullshit you ever so slightly.)
3. "We have a sophisticated financial model creating a robust Parametric VaR." (I am going to personally bullshit you with a tweaked Garch model or overly sensitive Levy Distribution)
Not knowing much you will nod and agree that, "the number looks about right." and sign off on the risk limits, now you are bullshitting yourself and the whole team.
I am not Against VaR or any other standard risk tool or view. I am against any tool which becomes institutionalized. Once a risk tool or approach becomes a wink and a nod, sign off or a CYA calculation it loses value. Risk management is meant for curbing human behavior, otherwise individual or collective greed wells up and overwhelms an organizing system of faith, which is what finance and money are.
Examples of institutionalized risk management beliefs that have or will become rubber stamps:
- Ratings Agencies (NRSRO ministry of truth)
- Securitisation magic (of course we all know that now)
- Basel II Capital Accords
- Probably the next financial innovation which will yet again revolutionize access to credit
- Any company wide policy which creates a ...Yeah but it passed the X test. Or well they signed off on it...type of mentality. See Dilbertian risk management.
The most dangerous risk manager or system is the one that becomes the de facto agreed standard we can all agree will stand the test of time. Once a unified risk belief is shared in aggregate all participants will start gaming or trading it the same way. When all participants share a similar view, the system is susceptible to harmonic dynamics. See the video below.