Idea of the day: Replacing VaR with leverage ratios
" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="false">
For all that Rick Bookstaber has taken potshots at Nassim Taleb in the past, his testimony today in front of the House committee on science and technology ultimately ends up in pretty much the same place as Taleb’s does.
Leverage is a direct result of underestimation of the risks of extreme events –and the illusion that these risks are measurable. Someone more careful (or realistic) would issue equity. April 28, 2004 was a very sad day, when the SEC, at the instigation of the investment banks, initiated the abandonment of hard (i.e. robust) risk measures like leverage, in favor of more model-based probabilistic, and fragile, ones.
And here’s Bookstaber:
There are two approaches for moving away from over-reliance on VaR.
The first approach is to employ coarser measures of risk, measures that have fewer assumptions and that are less dependent on the future looking like the past. The use of the Leverage Ratio mandated by U.S. regulators and championed by the FDIC is an example of such a measure. The leverage ratio does not overlay assumptions about the correlation or the volatility of the assets, and does not assume any mitigating effect from diversification, although it has its own limitations as a basis for capital adequacy.
Happily, I think they’re both likely to get what they want: the G20 seems determined to move to simple measures of capital adequacy, rather than the failed, complex measures which were embedded in Basel II. How long that will take, however, is unclear: bank regulation moves slowly at the best of times, and slower still when the changes are big.