Archive for the ‘Aaron Brown’ Category
A theme I’ve been thinking about for at least the last 2 years is the concept I call the “risks of risk management”. Is it possible that the recent introduction of highly quantitative risk management systems has actually increased market risk?
Here is something I posted to NP on March 16, 2006:
Since I suspect we have a ton of NPers who work in risk and, in particular, Aaron has finally obtained the critical 4 posts, I thought I’d ask a question, which is probably old news and has been discussed to death in a million places, but is on my mind.
When I look out at the world, one of the major risks to the markets that I see is, ironically, risk management. I suspect that one of the primary employers of junior quants in the last 5 years has been in risk analytics (HHs, please correct me if I’m wrong). If there is any truth to that, it means there is literally an army of quants who have not lived through a business cycle building risk systems on markets that no one really understands, e.g. CDS/CDOs.
From what I’ve seen, the actual “risk managers” are typically high level management who actually have very little clue about what is going on (except Nonius and Aaron of course ). For example, at my previous employer, one of the risk managers got his break because he would perform magic tricks at the company parties
If things are at all like what I have seen, then we’ve got a bunch of fairly clueless risk managers out there with an army of fairly green quants developing sophisticated risk models that are probably pretty useless in a crisis. Nonetheless, there seems to be this completely ludicrous false sense of security.
Across the boards, vols seem to be historically low which would mean that most VaR engines are saying “smooth sailing”. What happens if vol increases? Everyone’s VaR model is going to start sending out little red flags. Assets are going to start getting reallocated. Since everyone has almost identical VaR models, the signals will be pretty much identical at all firms. I know it is not an original argument, but this could easily lead to a negative feedback. A small red flag due to increased VaR could signal everyone to make very similar reallocations. If everyone does it at the same time, the market will obviously be affected. In essence, the impact of risk management could actually increase systemic risk in the markets and amplify vol movements.
I’m very curious to hear what others think. Is this a totally bogus line of thinking?
Any pointers to literature discussing this kind of thing would obviously be appreciated. Here is an article I found interesting on the subject
The impact of risk regulation on price dynamics
Jon Danielsson, Department of Accounting and Finance, London School of Economics, July 2002
Subsequent discussions were enlightening. If you’re at all interested in the subject of risk management, I encourage you to have a look.
If I combine this concept, i.e. risks of risk management, with the arrogant attitude toward risk at GS that I outlined on July 27 here
I have a pretty loose definition of “friend”. Anyone I’ve had a beer with is definitely a “friend” in my book and if that is the criteria, then Aaron Brown [the master of risk management] is a GOOD friend 🙂 Aaron wrote a fantastic article on VaR back in 1997 that I reference in that “Risks of Risk Management” thread on NP. It was such a good article, I’ll point to it again here:
I have absolutely no doubt in my mind that hedge funds, investment banks, and asset managers around the globe are succumbing to many, if not all these “VaR disasters”.
Actually, Aaron’s article is so good I decided to reproduce it here after the jump. It required more formatting than I’d like to admit, so any editing errors are likely my own.