Abstract
We now try to examine our risk measures and their properties in the practical context of daily risk management. We structure this chapter by the most common questions you might face, in reverse order of urgency.
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Notes
- 1.
We like to treat the VaR as negative value to preserve consistency with support measures like the VaR-contribution. We quickly translate “increase” into its opposite and keep mum about it.
- 2.
As we want to avoid the ambiguous “increase” and “decrease” for the negative VaR, the thesaurus is having a field day.
- 3.
Take, for example, VaR models that must estimate not overnight or 1-day PnLs, but 1- or 3-month PnLs. They may rely on correspondingly large historical returns, but this would make the returns either fewer or older or overlapping. Alternatively, they may try to use daily returns and project them farther into the future, which raises questions of reversion to the mean, among others. The frowned-upon traditional shortcut is to simply scale up the 1-day VaR by the square root of time (in days). Strictly speaking, this is somewhat off or incorrect, but it seems to usually do the trick. A proper long-horizon estimate, on the other hand, has ample leeway in terms of modeling and thus allows for a wide range of results, which doesn’t necessarily invite much greater confidence in it.
- 4.
Other out-of-scope parameters are fudge parameters ; they are introduced to circumvent numerical issues. An example is the shift used to make square root processes operate on negative interest rates.
- 5.
A good example is the RiskMetrics decay parameter setting of 94%. It often goes unscrutinized because it is so commonly used and ingrained in many model rehashes.
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Auer, M. (2018). Nine to Five. In: Hands-On Value-at-Risk and Expected Shortfall. Management for Professionals. Springer, Cham. https://doi.org/10.1007/978-3-319-72320-4_17
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DOI: https://doi.org/10.1007/978-3-319-72320-4_17
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