Don’t rely on VaR

Belief that a single number can capture the degree of risk being taken within a bank or an investment is mistaken, especially when that number is value at risk. Markus Leippold explains why the measure is flawed, points to the dangers of its widespread acceptance by regulators and investors, and suggests an alternative.

REGULATORS, POLICY MAKERS, and investors increasingly put pressure on banks, securities firms and hedge funds to include risk information in their financial reports. These groups want to understand the amount of risk being taken to produce returns so as to make better-informed judgments on the performance of financial institutions and investments.

To assign a number to returns is easy. It is the percentage number indicating by how much the money value of an investment has increased from the previous period.

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