SERVING THE QUANTITATIVE FINANCE COMMUNITY

 
User avatar
rpowell64
Topic Author
Posts: 2
Joined: July 27th, 2007, 8:13 pm

Complexity versus Simplicity in Risk Management

August 7th, 2009, 2:18 pm

It appears to me that the entire risk management profession has gotten carried away with mathematical wizardry. No where is this more evident than in the constantly mutating Value-at-Risk metric. At this point, there must be at least 100 variations on the original VaR concept. This complexity was driven by academics and practitioners constant quest to plug the holes (cover up the shortcomings) of each predecessor VaR permutation. In the final analysis, no single VaR number, no matter how rigorous the statistics and math behind it, can fully capture risk. Risk managers need to break free from the boundaries of higher-level mathematics when assessing risk. Precisely because the financial markets and instruments traded are complex, the methodologies used to assess their risk should be simple - by that I mean "general" and "flexible" and "adaptable" and hold your breath "more subjective." As a seasoned quant, I know the pitfalls of over-fitting a financial model - you end up missing the forest for the trees. The same holds true in risk management. I believe risk managers should turn off their computers (or UNIX terminals), take out a piece of paper, make a list of things that could go wrong, and think of safeguards to implement. This exercise doesn't require C++ code or stochastic calculus, but only real-world experience, creativity, and thought. Please let me know if you agree or disagree.
 
User avatar
Gmike2000
Posts: 801
Joined: September 25th, 2003, 9:49 pm

Complexity versus Simplicity in Risk Management

August 7th, 2009, 4:43 pm

It is exactly the other way around. Risk managers are (generally, there are exceptions) simple minds who never ever experienced the meaning of "risk" on a trading desk. They do not understand the complex models and strategies a desk uses to control risk. Instead, they have a need to simplify everything into a collapsed simple number. They believe ICAP is god and all "market quotes" brokers show have unlimited liquidity and can instantly be executed. They base all kinds of calculations on such quotes.....They use mathematics to impress even simpler minds (managers, controllers, auditors) and pretend what they do is scientific.Best risk managers are ex traders.
 
User avatar
DavidJN
Posts: 1757
Joined: July 14th, 2002, 3:00 am

Complexity versus Simplicity in Risk Management

August 7th, 2009, 5:37 pm

"This exercise doesn't require C++ code or stochastic calculus, but only real-world experience, creativity, and thought. "and"Best risk managers are ex traders."Sound to me like you guys are saying more or less the same thing.VaR is a concept that wasn't developed and is not viewed as useful by front office people. It was developed by consultants who, when they couldn't sell it to front offices, did an end round and sold the idea to the regulators, who then dictated that the street adopt the method. VaR is about as useful as tits on a bull.
 
User avatar
rmax
Posts: 6080
Joined: December 8th, 2005, 9:31 am

Complexity versus Simplicity in Risk Management

August 10th, 2009, 9:12 am

QuoteOriginally posted by: Gmike2000Best risk managers are ex traders.I do agree with this on the whole, however to play devils advocate: you don't think that traders will always have a trading mentality, and hence you should hire people who have a risk management mentality?
 
User avatar
Vegawizard
Posts: 157
Joined: November 27th, 2006, 10:46 am

Complexity versus Simplicity in Risk Management

August 10th, 2009, 9:23 am

QuoteOriginally posted by: rmaxQuoteOriginally posted by: Gmike2000Best risk managers are ex traders.I do agree with this on the whole, however to play devils advocate: you don't think that traders will always have a trading mentality, and hence you should hire people who have a risk management mentality?Ideally you need a thief to catch a thief. Traders understand the nuances of mark to market, mark to model, and other subjective variables and loopholes to game the system. I would agree that ex-traders would tend, on average, to make better risk managers.
 
User avatar
hamster
Posts: 216
Joined: October 12th, 2008, 3:51 pm

Complexity versus Simplicity in Risk Management

August 10th, 2009, 11:17 am

it s useful to know what is the set of events. data might not tell you.
 
User avatar
rpowell64
Topic Author
Posts: 2
Joined: July 27th, 2007, 8:13 pm

Complexity versus Simplicity in Risk Management

August 10th, 2009, 4:02 pm

I would favor a Risk Manager with a lot of practical, real-world experience on a trading desk vis a vis someone with a PHd in a quantitative discipline with no experience. However, I do not agree that ex-traders make the best risk managers. While ex-traders do have desirable practical experience, they may not have the appropriate temperament or mind-set to be effective Risk Managers. The major problem is that Traders are usually not incented to manage risk appropriately. This leads the typical Trader to develop a mind-sets that is contrary to prudent risk management. I do not believe it is easy for a long-time Trader to change his or her orientation towards risk-taking.
 
User avatar
Vegawizard
Posts: 157
Joined: November 27th, 2006, 10:46 am

Complexity versus Simplicity in Risk Management

August 11th, 2009, 7:34 am

You make a valid point rpowell, but not all traders are all-out 110% BSD risk-takers. There are many "mediocre" traders whose shortcoming is perhaps too thoughtful, too cautious, wanting to consider all the variables before pulling the trigger. Paralysis from over-analysis?I firmly beleive their needs to be much more focus on risk management, rather the the current trend of risk measurement and quantification?I subscribe to Bookstabers' view in his book A Demon of our own design.Thus the insight/experience angle of an ex-trader is of more relative value than trying to create complex oversimplication "risk numbers" that often mask real underlying risk and are difficult if not impossible to fully understand by people charged with managing the risk?
 
User avatar
jomni
Posts: 999
Joined: January 26th, 2005, 11:36 pm

Complexity versus Simplicity in Risk Management

August 11th, 2009, 8:21 am

QuoteOriginally posted by: VegawizardQuoteOriginally posted by: rmaxQuoteOriginally posted by: Gmike2000Best risk managers are ex traders.I do agree with this on the whole, however to play devils advocate: you don't think that traders will always have a trading mentality, and hence you should hire people who have a risk management mentality?Ideally you need a thief to catch a thief. Traders understand the nuances of mark to market, mark to model, and other subjective variables and loopholes to game the system. I would agree that ex-traders would tend, on average, to make better risk managers.They might know the market and risks pretty well but not all of them are well organized, able to write clear policies, enforce the rules, deal with regulators, do proper documentation of their models, etc.
Last edited by jomni on August 10th, 2009, 10:00 pm, edited 1 time in total.
ABOUT WILMOTT

PW by JB

Wilmott.com has been "Serving the Quantitative Finance Community" since 2001. Continued...


Twitter LinkedIn Instagram

JOBS BOARD

JOBS BOARD

Looking for a quant job, risk, algo trading,...? Browse jobs here...


GZIP: On