Commentaries

The VaR cover-up

By Pablo Triana

Pablo Triana is the author of Lecturing Birds On Flying: Can Mathematical Theories Destroy The Financial Markets? The views expressed are his own

Last month, several men and women assembled in a somber room in Washington to discuss one of the key issues (in my opinion, the key issue) behind the financial crisis that has caused so much misery.

Among those gathered were leading politicians and top financial professionals. A world-renowned bestselling author was there, too. You might think that the media would have devoted attention to such an important event. Surely journalists wouldn’t want to miss the opportunity to report on a roundtable of policymakers and experts that promised to tackle the true factors behind the mayhem, right?

Wrong. (more…)

Goldman, liquidity and VAR

Goldman Sachs’ second-quarter earnings release showed a continued increase in the amount of market risk held on the firm’s trading book. Its risk appetite has continued to expand at a time when extreme turbulence has forced others to scale back.

True, Goldman’s publicly reported figures may overstate its actual positions. But the Wall Street bank also appears to be taking advantage of its access to liquidity from the Federal Reserve to increase risk.

Total value-at-risk (VAR) averaged $344 million, on a gross basis before diversification effects, up from $303 million in the second quarter of 2008 and $226 million in the second quarter of 2007. 

Click chart to enlarge in new window.  Additional data available here.

(VAR is a crude measure of the worst loss the firm would expect to report on 19 days out of 20, given prevailing volatility in the market.)

Like other banks, Goldman reports VAR on a net basis after taking account of a “diversification effect”. The diversification effect reflects the fact that risks in different parts of Goldman’s book are not perfectly correlated.

The bank would not expect to lose the maximum amount on all its positions at the same time. So net VAR for the book as a whole is less than the sum of the VARs for the individual components (which Goldman reports as currencies, interest rates, equities, and commodities). Goldman’s net VAR in the second quarter averaged $245 million, up from $184 million in the second quarter of 2008 and $133 million in the second quarter of 2007. (more…)