VAR “not to blame” for 1998 crisis, says leading academic

“There is no evidence to support the assertion that VAR-based risk management systems destabilise the financial system,” says University of California at Irvine professor Philippe Jorion, in a paper just published in the fall 2002 edition of The Journal of Risk .

In his paper, 'Fallacies About The Effects of Market Risk Management Systems', Jorion takes a fresh look at allegations that risk management systems based on VAR measures contributed to increased volatility in financial markets in the wake of the near-collapse of the Long-Term Capital Management hedge fund in 1998.

Some commentators have claimed that VAR measures – which define a maximum loss over a target horizon – encourage a vicious circle of position-cutting by traders when financial markets weaken sharply and banks struggle to maintain their regulatory capital ratios.

But Jorion, who is also the editor of The Journal of Risk, said his paper provides new evidence that VAR regulatory charges for commercial banks cannot be blamed for the volatility of 1998. The paper shows that: “Market risk charges move very slowly in response to changing market conditions due to the averaging over the last 60 days and slow updating imposed by Basel [capital adequacy] rules.”

For more on the Journal of Risk see: www.thejournalofrisk.com.