VaR plays an important role as a risk measure, and many traders state that they are employing VaR as primary risk management tool. Also, most of the advanced ETRM system states VaR support as one of the main functionality of their solution. VaR can be used for many purposes, for example, risk control, risk reporting (but no control), performance evaluation and capital adequacy. In this article, I would like to share lessons I learned from my past works where VaR is used as a daily control measure.
A typical business case goes like this. After book closing, you only have 6-8 hours to prepare a final report. End-of-day exposure and P&L is calculated, and finally, you get VaR number, typically at the very end of the EOD process. Suppose you find VaR exceeds prescribed limit, and according to your internal regulation you have to ask traders to liquidate his position, or to hedge, to reduce VaR. First of all, you have to check if the calculated number is correct and re-calculate VaR if you find any error. Then you communicate with the trader, explain what happened, help him build an action plan, and prepare the final report. Can you complete the task within 2-3 hours?
It’s not easy, but not impossible. Once you get used to it, it’s manageable. But you need additional tools, IT systems, business logic and communication protocols specifically set up for daily VaR control. I’ll discuss on issues and guidelines for each step of preparation, validation, attribution, simulation (I will not discuss VaR measurement itself). Continue Reading in LinkedIn