on April 18, 2011
"If you are distressed by anything external, the pain is not due to the thing itself but to your own estimate of it; and this you have the power to revoke at any moment".
Marcus Aurelius has summed it up appropriately in his "Meditations on Stoic Philosophy" and Bubble Value-at-Risk exercises this power not to revoke but to refine.
Value-at-risk has a rather dubious track record as a basis for calculation of risk capital. Exaggerated reliance on this tool by the regulatory authorities only exacerbated the fall out of bad judgments based on this "intuitive" estimate of risks. Can "Stressed Value-at-risk" generate sufficient prudence to save for the proverbial rainy day? Are the regulators geared up to face "adaptive challenges" or have they become prisoners of their own system?
Max Wong's book is an ideal expression of his self-reflection on the issue of capital buffers (or rather the lack of them!). The concept of BuVaR (Bubble Value-at-Risk) germinates from his ideas of an "ideal capital regime" based on his own way of processing business cycles as a risk management practitioner. Distorting or even drowning the VaR noises and re-viewing patterns in the risk environment led him to a simple but key question "isn't the risk of a crash higher at the peak than at the trough?" And, what is more, crashes always occur one way, downwards!
The BuVaR attempts to do away with the major shortcomings of VaR - Too Little, Too Late. BuVaR is sure to appeal to regulators as it is conservative and penalizes position taking in the direction of a bubble (in the case of Market BuVaR) and its extension into the world of credit (Credit BuVaR) helps aggregate default risk with credit VaR to sound the alarm of credit deterioration way ahead of time.
* What makes the book highly readable is the fact that the author cares enough for the mathematically-challenged to re-build the entire VaR architecture with simple building blocks, along with common sense assessments of the model along the way. The reader is thus prepared to understand BuVaR in the right context.
* The "New Interpretation" of Classical Decomposition is a way to make distributional forecasts more aligned with business cycles. This view definitely appeals to the economist in me who perpetually wonders about the "thin veil of money over the real world".
* What gives this book a "double thumbs" up is the easy conversational style of writing, particularly in delineating technical concepts. The axiomatic frame of reference is well-defined and conclusions are consistent with underlying axioms. Bankers and non-bankers alike would find this book an informative read.
However, I personally believe the primary audience for this book will be those who wish to soften the effect of speculative crashes on the unsuspecting public. Regulators and other policy makers would benefit from reading the book as it will sharpen their understanding of widely-used mathematical models from premises that are purely philosophical.
- Jayaradha Shankar (formerly Assistant General Manager, Reserve Bank of India)
on September 17, 2011
Having worked in the insurance industry for a number of years, I have had strong doubts about using standard VAR metrics to manage regulatory capital. In particular, it seemed strange to me that VAR did not seem to take account of market cycles, was highly reliant on historical data and only recognised regime shifts after the fact. The result of this would seem to be a highly procyclical capital regime, forcing regulated entities into large sell offs at the bottom of the market and resulting in the type of risk aversion and liquidity trap we are all too familar with in recent years.
This book works on two levels. Firstly, it provides an easy to understand critique of the mathematical assumptions underpinning VAR, going beyond the well rehearsed issues with assumptions of normal distribution and fat tails. Secondly, even more importantly, it provides suggestions for the way forward both for calculating capital at the entity level and managing systemic risk at the global level. While a basic understanding of statistics would be useful, a lot of the most important ideas are explained in a way that you do not need any mathematical background to understand.
I highly recommend this book for anyone with an interest in the calculation of regulatory capital and management of systemic risk - both extremely topical in the current business environment.
on January 16, 2012
Despite being in essence a critique on VaR and a recommendation for a more "macroprudential" risk measure (the author's "Bubble VaR"), this is actually an excellent and accessible description of the standard VaR measure itself. It's worth getting for that reason alone, Mr Wong's writing style is so clear and lucid that he makes a very arcane and technical subject (almost) an easy read.
He is right to point out the obvious limitations of VaR, although I often think the complaints of VaR stem as much from a misunderstanding of what it was always supposed to be, compared to what it obviously couldnt do but was touted as being good for, if you know what I mean. The author recommends the Bubble VaR technique as a means to avoid the limitations of VaR and move towards a more accurate risk exposure estmation over the cycle. In that regard, this is definitely worth reading, especially by all bank CROs.
A great effort with Book No. 1. I look forward to Mr Wong's next works.
on May 20, 2013
a new way of measuring VaR, a new methodology, more realistic, more adapted, more global, an new frontier in Risk Managment!