Value at risk

always seemed a bit fishy to me. But I always found Taleb’s discussions lame—he tore it down, rather than offering any concrete solutions to the question: how much risk should I take? How can people make that decision?

Value at risk – Wikipedia, the free encyclopedia

And regulating it probably caused trade in “model risk:” Model Risk

A type of risk that occurs when a financial model used to measure a firm’s market risks or value transactions does not perform the tasks or capture the risks it was designed to.

Model risk is considered a subset of operational risk, as model risk mostly affects the firm that creates and uses the model. Traders or other investors who use the model may not completely understand its assumptions and limitations, which limits the usefulness and application of the model itself.

The main risk driver in low credit quality mortgages is level and the dynamics of the default rate, and any associated risk premiums. The default rate is measuring tails, so it is impossible to measure with any precision. So the levered mortgages positions are levered bets on model parameters…

Of course if you bet right, big wins. If you bet wrong, big losses—unless you are ‘too big to fail.’ I have no idea right now how much the implicit insurance cause people to over-lever, verus people who really believed the models. I am suspicious of people who tells us that they know what drove things…

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