Virtually every financial institution with a risk management function uses the value-at-risk or expected shortfall measure to set limits for traders. So it is unsettling to find that, according to new research, these popular gauges are not a good way of curbing risk-taking behaviour.
In a recent Risk.net article, Rogue traders versus value-at-risk and expected shortfall, John Armstrong, a senior lecturer at King’s College London, and Damiano Brigo, the head of the mathematical finance group at Imperial College London, show risk limits set according to classical VAR and expected shortfall-based models are not breached when rogue traders take more tail risk – exposing their positions to extreme losses – while staying within a set budget…
