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Practice paper

When swans are grey: VaR as an early warning signal

Daniel Satchkov
Journal of Risk Management in Financial Institutions, 3 (4), 366-379 (2010)
https://doi.org/10.69554/LIFH4142

Abstract

The market events of 2008 will be remembered as much for their extreme volatility as for a widespread failure of the risk management, which contributed to the near collapse of many firms thought to be among the leaders in that field. This paper identifies a key deficiency in the way that the historical data are currently utilised in the estimation of risk. This deficiency stems from the conception of the marketplace as an equilibrium-seeking and continuous system and it led to the financial firms’ unpreparedness for sudden market reversals. A different framework for risk estimation is proposed based on linking the risk modelling with the existing literature on financial instability. One possible application of the proposed method to the estimation of value-at-risk (VaR) is demonstrated, and empirical tests comparing it with the traditional methods are performed using S&P 500’s history from 1989 to 2010. The new measure, called the instability VaR, is shown to dominate all traditional methods of calculation.

Keywords: market crises; VaR; early warning indicators; market bubbles; risk mispricing; financial instability hypothesis

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Author's Biography

Daniel Satchkov is the President of RiXtrema Inc., a risk modelling and consulting firm that focuses on the extreme financial market events. Prior to founding RiXtrema, he was an Associate Director of Risk Research at FactSet, where he was responsible for researching and developing software products in the areas of risk measurement and risk reporting. He has spoken at numerous conferences and published articles dealing with risk management issues in such magazines as Journal of Asset Management, Investment and Pensions Europe, as well as in a number of white papers and an e-book. Daniel’s current research is in the area of extreme market events, credit cycles and behavioural finance. Daniel holds BS and MBA degrees from the University of the Pacific.

Citation

Satchkov, Daniel (2010, September 1). When swans are grey: VaR as an early warning signal. In the Journal of Risk Management in Financial Institutions, Volume 3, Issue 4. https://doi.org/10.69554/LIFH4142.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 3 / Issue 4
© Henry Stewart
Publications LLP

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