Bookstaber's testimony on risk

September 11, 2009 in Finance,Risk

Rick Bookstaber testified to the House on Wednesday regarding risk management; the text of his remarks is available here. It is a must-read.

The bulk of his testimony focuses on VaR: it's use, misuse and role in the recent crisis. I find his greatest insight in this paragraph:

I remember a cartoon that showed a man sitting behind a desk with a name plate that read ‘Risk Manager’. The man sitting in front of the desk said, “Be careful? That’s all you can tell me, is to be careful?” Stopping with the observation that extreme events can occur in the markets and redrawing the distribution accordingly is about as useful as saying “be careful.” A better approach is to accept the limitations of VaR, and then try to understand the nature of the extreme events, the market crises where VaR fails. If we understand the dynamics of market crisis, we may be able to improve risk management to make it work when it is of the greatest importance.

But stop reading here and check out the testimony in its entirety. It is an excellent example of gentle writing that nonetheless contains a critical message. Also, don't miss a reprint of Bookstaber's attack on fat-tails as a straw man argument. I hadn't seen such a description in print before, but I'm inclined to agree.

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