By Tracy Alloway, Bloomberg 13rd May 2015
Peer under the proverbial hood of a big bank or investment company's risk management chassis and one might see a mathematical model that looks something like this.
"Value at Risk," or VaR, models use statistical analysis and historical data to attempt to quantify how much an investor might expect to lose from trading within a certain time frame and within a certain probability. While such VaR models were criticized in the aftermath of the financial crisis for failing to predict heavy losses incurred on subprime mortgage securities and associated assets, they still form the backbone of Wall Street's risk management systems. Traders operate within their limits; woe betide the junior trader who exceeds VaR.
But big market moves have been occurring more frequently in recent months, and that's wreaking havoc with VaR models built on certain expectations of the way markets move.
These "VaR shocks," as they're known, can be painful for investors because they often require them to cut positions in order to return to within their VaR limits.
Here is a terribly simplistic list we've drawn up, showing all the major VaR shocks we can remember in recent history.
- 2003, June : The prices of Japanese government bonds slumped suddenly, causing Japanese banks to bump up against their VaR limits and sell-off their JGB holdings.
- 2008, October: Widespread market turmoil causes a sharp uptick in VaR across the financial system.
- 2013, June: The "taper tantrum" sparks a selloff in U.S. Treasuries, with at least one bank reportedly breaching its VaR limit.
- 2014, Oct. 15: U.S. Treasury market suddenly "melts-up," causing investors to quickly reposition their portfolios.
- 2015, January: The Swiss National Bank unexpectedly removes its currency floor, causing a further VaR shock.
- 2015, May: Investors sell German government debt, with market participants labeling the event the latest VaR shock.
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