Value at Risk Workshop, (One Day)

Value at Risk (VaR) was hailed two decades ago as the new way to measure and manage market risk. Risk managers loved it, traders mistrusted it, regulators "hard-wired" it and Boards were confused. Nevertheless it's now widely used.

It's advantage is clear, it adds a statistical measure or level of confidence. Unfortunately its major weakness is that in times of stress (the very time you rely on it) it doesn't work. Does that mean that VaR is a pointless or even dangerous measure? That's not an easy question to answer. It depends on how you calculate it, what you use it for and importantly what other risk measures you use.

It's understandable that many smaller firms dont use VaR. It's a decision based on what they do and the resources at hand. Larger firms use it. They recognise its strengths and weaknesses. They explore outliers, look for changes and trends and apply more severe tests to simulate what could happen when markets "gap down".

What this workshop does is to provide you with a fundamental understanding of the topic. Training will be in a workshop format. This will include a mixture of presentation and case study material. The course is designed for up to twelve staff. Knowledge of risk management is not required but knowledge of financial products and markets would be helpful.

Below is a summary of the workshop. The content has been placed in a logical sequence and addresses the techniques, application, strengths and weaknesses of VaR.

**Market Risk **- This section explains why market prices move, how traders attempt to hedge market risk and the impact that this can have on the P&L. It will also explain the need for quantitative measurement.

- What it is
- How it occurs
- Combinations of risk reports
- Simple measures
- Interest rate gaps and deltas
- Strengths & weaknesses

**Value at Risk - **We will consider what goes into a VaR model and importantly what comes out. Is VaR fit for purpose or does it lead to overconfidence in the management of risk?

- What it is
- Inputs into the VaR calculation
- Volatility
- What it is, two measures
- Normal Distribution
- Using volatility and normal distribution
- How much can we lose?
- Confidence intervals
- Increasing volatility
- How much risk do we have?
- Risk appetite & risk limits – what’s appropriate?
- Time horizon
- Should we use one day, ten day or some other holding period?

**Revisiting Normal Distribution - **Why do markets behave differently and what can we do about it?

- Skewness, Kurtosis and Leptokurtosis
- The tail problem and “fat-tails”
- Expected shortfall

**VaR and Diversification - **They say diversification reduces risk. That may be true but should we rely on it with our VaR model?

- Portfolio theory
- Correlation – what it is, how it’s used in VaR
- Two measures- diversified and undiversified VaR, what’s appropriate?
- What happens when “predictable” correlations breakdown?

**VaR Methodologies - **Which is best? A hard question to answer but something we need to think about in terms of what we are trying to do and the resources at hand.

- Parametric (variance, covariance model)
- Historic simulation
- Monte Carlo simulation
- What they are, strengths and weaknesses

**Backtesting - **Does your VaR model work?

- How and why it’s undertaken

**The Governance of Risk - **We know it's important but just how does VaR impact on governance? How does it fit in with risk appetite?

- Quantitative and qualitative measures of risk and their impact on VaR
- Risks VaR doesn’t hedge

**Additional risk measures - **Do you need other measures to get a better picture of the risks you face?

- Drawdowns
- Point of ruin (concentration risk)
- Expected Loss
- Stress testing

**Contingency planning - **The things you constantly need to monitor that may give you an indication that something is not quite right.

- Early warning indicators
- Improved management information
- Simple and effective estimates of VaR

**Three lines of defence - **Don't let complexity overule robust operating procedures.

- VaR and the risk of fraud

23rd January 2010

In a world where regulators are focusing on liquidity and capital it's easy to overlook market risk. In many firms this means interest rate exposure. In the UK with Bank Rate at an all time low it's tempting to think that hedging fixed rate assets is just a waste of money. After all why pay 3.25% on a 5 year swap when 3 month Libor is only 51 basis points? Surely matching the interest basis on assets and liabilities ends up costing you 274 bps doesn't it?

19th May 2011

Presentation: ALM Good Practices Seminar 18th May 2011