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Explain the VaR framework and its utility in Risk Management
Finance & Accounting
Pages 12 (3012 words)
Explain the VaR framework and its utility in Risk Management. Could its correct application prevent financial disasters like Barings Banks and Long-Term Capital Management? 1 Introduction In the background of financial disasters that occurred in the early 1990s when many industry giants like Barings, Orange County, Daiwa, and Metallgesellschaft declared bankruptcy and due to this, VaR (Value at Risk) as a new phenomenon of risk management was introduced.
VaR can be said to be an easy method of measuring the market risk. As of date, VaR technology has spread its wings well beyond financial derivatives and is completely transforming the style the financial institutions’ approach to their financial risk. Initially, VaR is employed to measure the market risk, but now it is being employed to administer and control risk actively. The VaR methodology is now assisting the industry to reckon both operational and credit risk, resulting in the sangraal of companywide management of risk1. (Jorion 2009: x). VaR employs a method of valuation of risk that uses standard statistical methods employed regularly in other technical sectors. In simple terms, VaR can be explained as the most speculative loss over an objective horizon that will not be surpassed with a given level of confidence. Footed upon the company’s scientific founding stones, VaR offers users with a detailed synopsis of market risk. (Jorion 2009: x). . 2 Backgrounds For those companies and financial institutions that are vulnerable to risks, management of risk is a vital function. ...
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