A Decade of VaR
Apr 05, 2006
RiskMetrics™ VaR methodology, the now ubiquitous but somewhat discredited market and credit risk model, was published by J P Morgan in the autumn of 1994. It was a covariance approach to estimating market risk and perhaps, therein lay the seeds of its downfall. Covariance, loosely defined as the joint movement of two or more assets (random variables), methodology, which was also the foundation of the mean-variance analysis of the CAPM, had been in existence since the mid 1950s. However, RiskMetrics™ formalized this approach as applied to the estimation of market risk in its Value at Risk (VaR) approach
Covariance is the easiest form of VaR calculation to implement and its publication was a boon to all banks as they could now freely access the methodology, algorithm(s) and the data set behind the risk calculations. For many years after its publication J P Morgan also facilitated the free distribution of volatility and correlation data sets needed for VaR calculations using RiskMetrics™.
This was a landmark event in the history of banking and risk regulation as this – the free availability of historical data sets for volatility and correlation of a large number of assets coupled with a free access to the methodology and algorithm to estimate market risk – enabled the regulators to incorporate, for the first time, a uniform risk estimation methodology in the risk regulation and compliance framework.
Note: The above knowledge is freely available on the web and numerous books, though we have used Implementing Value at Risk by Philip Best as our reference.......
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