Viva lost vegas

Brett Humphreys discusses the problems of calculating true value-at-risk on aconcentrated options portfolio – in particular, the various pitfalls thatcan befall a risk manager in ignoring vega risk – and considers ways ofhandling these issues

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A risk manager is having an argument with his trading group. In a rare moment of honesty, the trading group says that because the company’s value-at-risk (VAR) calculation does not include vega risk1 and its portfolio contains a large number of options, the calculated VAR number is probably too low. The risk manager knew that vega was ignored, but always believed that vega risk was minor compared with that of the total portfolio. However, to try to improve the model, he decides to

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