A short note on the concept of risk management and VaR for asset management firms

Value at risk (VaR) is now the most commonly cited risk management tool for asset managers to utilize. Specialized tools are used for particular types of management problems, usually grouped into the fixed income camp of duration and convexity or derived directly from options theory. In general, however, most firms utilize some type of VaR type analysis, if any analysis is done at all. This note points out the problem of using VaR without understanding that the answer one obtains when applying the tool is highly dependent upon the question being asked. That is, simple VaR is very useful for certain circumstances, but not too useful for many of the issues to which it is applied by asset managers. The conclusion is simplistic in that managers must use the correct tools for the question being asked if a useful, and not misleading, answer is to be obtained. VaR often provides elegant answers to the wrong questions. Interestingly, many of the questions VaR is best suited to answer were answerable using Chebyshev' work of 150 years ago.