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Abstract

Value at Risk (VAR) models are mathematical tools for risk management. Their most dramatic failure was in the near bankruptcy of Long Term Capital Management. This case study describes the variant of VAR used by a global financial institution ''RMIC bank'', to manage financial exposures globally, and specifically in Asia, and the chain of events that led to significant losses throughout the region following Thailand''s decision to float the boat on 2 July, 1997. Among the issues examined in this study are: (1) why did seasoned capital-market players fail to recognise the flaws in VAR?; (2) should VAR models be discarded, or can they still be useful tools when applied with appropriate circumspection?; (3) how can VAR and macroeconomic tools be used to spot signals of impending capital-market crisis in sufficient time to avoid major losses?; and (4) why should risk management be regarded as a critical success factor in performance evaluation? The hypothetical ''RMIC Bank'' is a fictitious composite based upon amalgamated financial and anecdotal information from several different, but real, financial institutions. Various anecdotal references are drawn from several firms. All of the numbers, which relate to risk limits, financial exposures, profits or losses, are hypothetical. However the figures do, in the authors'' estimate, accurately reflect the general magnitude of a situation faced by several real competitors at the time.
Location:
Industry:
Other setting(s):
1990-1998

About

Abstract

Value at Risk (VAR) models are mathematical tools for risk management. Their most dramatic failure was in the near bankruptcy of Long Term Capital Management. This case study describes the variant of VAR used by a global financial institution ''RMIC bank'', to manage financial exposures globally, and specifically in Asia, and the chain of events that led to significant losses throughout the region following Thailand''s decision to float the boat on 2 July, 1997. Among the issues examined in this study are: (1) why did seasoned capital-market players fail to recognise the flaws in VAR?; (2) should VAR models be discarded, or can they still be useful tools when applied with appropriate circumspection?; (3) how can VAR and macroeconomic tools be used to spot signals of impending capital-market crisis in sufficient time to avoid major losses?; and (4) why should risk management be regarded as a critical success factor in performance evaluation? The hypothetical ''RMIC Bank'' is a fictitious composite based upon amalgamated financial and anecdotal information from several different, but real, financial institutions. Various anecdotal references are drawn from several firms. All of the numbers, which relate to risk limits, financial exposures, profits or losses, are hypothetical. However the figures do, in the authors'' estimate, accurately reflect the general magnitude of a situation faced by several real competitors at the time.

Settings

Location:
Industry:
Other setting(s):
1990-1998

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