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USE OF VAR FOR MARKET RISK
Dr Philip Symes
Copyright 2006 Asymilate Consulting Ltd. All Rights Reserved
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Introduction
This presentation focuses on several questions about the
use of VAR:

o! shoul" VAR anal#sis best be use"$

In !hat conte%t is VAR an effective &ana'e&ent tool$

o! shoul" VAR be use" b# &ana'e&ent$

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Why VAR?
(h# "i" ban)s choose to i&ple&ent VAR$

*erceive" best practice+ e,', in RiskMetrics,

One nu&ber for senior &ana'e&ent focus

Re'ulator# capital benefits,

Econo&ic capital benefits,

So&e tra"ers sa! opportunities for increase" &ar)et ris) li&its

-UT:

-an)s "i" not al!a#s follo! a lo'ical path to intro"ucin' VAR

Metho"olo'ies !ere intro"uce" !ithout proper un"erstan"in'

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Why VAR?
o! is VAR no! use"$

Ris) .ontrol &onitor VAR a'ainst li&its

/i&its are nor&all# at business unit rather than "es) or tra"er

Tra"in' li&its usin' sensitivities still presi"e over VAR !ith hi'her
'ranularit#

*0/ attribution is perfor&e" usin' sensitivities not VAR

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Using VAR

So&e e%a&ples of !hen VAR chan'es:

&ar)et rate chan'es !ith positions unchan'e"

positions chan'e+ &ar)et rates sta# the sa&e

the historical ti&e series use" is &o"ifie"

All three of the above have an i&pact on "ail# profit an" loss
but the chan'e in VAR is 1OT the chan'e in valuation of the
transactions

There are co&ple%ities:

If VAR is "ee&e" the &ar)et ris) capital !hat returns

shoul" be use" for a ris)2a"3uste" calculation$

Shoul" !e split the return into its co&ponent parts 4&ar)et+

cre"it+ operational+ other ris)s$5

o! "o !e "eal !ith intra2"a# tra"in' the *0/ for !hich is

in returns but not in VAR$
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Using VAR
VAR can best be use" as a blunt tra"in' &ana'e&ent tool or a
robust ris) control6&ana'e&ent tool:

.onsoli"ate ris) across the fir& for &ana'e&ent

*rovi"e a 7portfolio8 vie! of ris) across &ultiple tra"in' "es)s

e%pose" to the sa&e ris) factors

*rovi"e tra"ers !ith an alternative vie! of ris) in their boo)s to

the &ore accepte" sensitivities ris) anal#sis

9elta VAR+ intra2"a# can provi"e the sole &ar)et ris) li&it
allocation &etho"olo'# but en" of "a# can8t

:uic)l# Focus tra"in' &ana'e&ent on &ar)et ris)

concentrations requirin' re&e"ial action b# tra"ers
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Using VAR
Usin' VAR "a#2to2"a#:

9ail# ris) appetite set b# the ea"s of Invest&ent -an)

Tra"in' at &ornin' &eetin's

En" of "a# VAR nu&bers "istribute" fro& central en'ine to

"ealers tra"in' s#ste&s

1e! VAR li&its set in &ornin' &eetin' b# unit an" translate"

into sensitivities for tra"in'

9elta VAR &etho" use" for intra2"a# reportin' to senior

&ana'e&ent 4e,', linear 7&ar)2to2future85

;lobal boo)s passe" to ne%t ti&e <one

Repeat process
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Pros & Cons of VAR
*ros of usin' VAR:

Tool for perfor&ance &easure&ent base" on ris) ta)en+ not

3ust to"a#8s 'ross return

9efines !hat is lo! or hi'h ris)

.onstant reference point for staff

Allo!s for ris)2re"ucin' benefits of "iversification at a portfolio

level

More infor&e" "ecision &a)in' on tra"in' strate'# an" pricin'

.orporate focus on un"erstan"in'+ &easurin' an" controllin'

ris)

.onsistent &easure&ent tool

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Capital Management
.ons of usin' VAR:

1ot all tra"in' instru&ents have "efinable ris) para&eters

/oss esti&ates "epen"ent on chosen confi"ence level

9ifficult to "eter&ine the i&pact of &ar)et liqui"it#

Future M2to2M values+ especiall# for co&ple% "erivatives+ can

be co&ple% an" is still evolvin'

Volatilities an" correlation=s are "ifficult to pro3ect an" var##

over ti&e

Or'ani<ational issues that can li&it effectiveness

S#ste&s li&itations

Ina"equate operational .ontrols

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Summary

There are still questions about the proper use of VAR

1ee" to un"erstan" !h# it is bein' use"

So&eti&es VAR &i'ht not be properl# un"erstoo"

VAR nee"s to be reassesse" "ail#

There are pros an" cons for usin' VAR

It shoul" be use" as one part of a holistic ris) anal#sis

VAR calculation is not a substitute for business 3u"'e&ent an"

stron' internal controls,