var_overhead - VaR 1 Need for Risk Management Example:...

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Unformatted text preview: VaR 1 Need for Risk Management Example: (from Jorion (2001), Value at Risk ) David Askin managed $600 million fund invested in collateralized mortgage obligations (CMOs) somewhat like derivatives difficult to price Askin claimed his funds were market neutral with no default risk, high triple-A bonds, and zero correlation with other assets Askin used his own model to identify, purchase, and hedge underpriced securities VaR 2 objective was 15% return leveraged so a total of $2 billion was invested Askin was betting on interest rates remaining low Feb Apr 1994: rates go up collateral call VaR 3 $600 million hedge fund reduced to $30 million irate investors claimed they were mislead it is true that they had little idea of the risks Askin used valuation models to price his position first reported a 2% loss revised to 28% investors were subject to market risk liquidity risk model risk VaR 4 Barings Feb 26, 1995: 233-year old Barings PLC goes bankrupt rogue trader 28-year old Nicholas Leeson lost $1.3 billion (more than the firms equity capital) Leeson bought stock index futures on the Nikkei 225 ($7 billion position) beginning of 1995 value fell more than 15% Barings was a conservative bank so this was a wake-up call VaR 5 Problems: lack of control: Leeson was in charge of trading desk and back office Singapore and Osaka exchanges did not notice the size of the positions problem was not peculiar to derivatives VaR 6 Origins of Value-at-Risk From Jorion: Till Guldimann was head of global research at J.P. Morgan in late 80s risk-management needed to decide between long bonds stable earnings cash stable market value decided that value risks were more important that earnings risk VaR 7 concern at this time about managing derivatives risks Group of 30 (with representative from J.P. Morgan): G-30 report in July 1993 used term value at risk October 1994: J.P Morgan introducesOctober 1994: J....
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This note was uploaded on 04/06/2008 for the course ORIE 473 taught by Professor Anderson during the Spring '07 term at Cornell University (Engineering School).

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var_overhead - VaR 1 Need for Risk Management Example:...

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