Published by sunandoroy on Fri, 2007-08-17 07:18
Add new Risk Management in Emerging Markets
Subprime Woes- VaR Models in need of Generational shift?
Published by sunandoroy on Fri, 2007-08-17 07:18
The US, seen through EME lenses, is the Mecca of Risk Management. And yet, the Subprime defaults catch the sophisticated market risk managers by surprise. Why did the market failed to foresee the looming dangers , catch the early signals and take steps to mitigate the risks. The risk managers, who step in at the first stage of the process-namely, identification will have to sort certain things out. There is little doubt that there is something missing in their arsenal that enables the near accurate capture of market risk.
One strange thing with research related to VaR models is that while too much emphasis has been on taming the distributional irregularities, little work took place on integrating market and liquidity risk in a VaR framework.
The responses, in many cases, have been very ad-hoc in nature. For instance, an easy and widely used solution has been to extend the holding period to compensate for illiquidity. Academic research – namely the transaction cost approach or the liquidity discount approach were never really tried out in practice as they needed huge trading data. Even the Wharton model ( Bangia et al, 1999) using bid-ask spreads were not used to mark up VaR with cost of liquidity. I think we cannot leave out liquidity risk from VaR models calculating market risk. This will leave out a major risk leaving VaR models redundant in times like this. A link here on the topic :
http://www.rbi.org.in/scripts/PublicationsView.aspx?id=7918
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