VaR: very absolutely relative

i read an article in the new york times magazine on risk, specifically in light the financial crisis. i found it rather intriguing, which surprised me. usually my dad and brother get going about the market, dividends, puts & calls, and you can bet they only puts and calls i'm registering are calling on them to put me out of my misery.

in this article, though, a great emphasis was placed on VaR (value at risk). if i understand it correctly, a group of really smart people came up with this collection of statistics and probabilities that, when taken together, assesses a portfolio's (and on up to the company's) risk in a 24 hour period. so, for example, if you have $50 million of weekly VaR that means that over the next week there is a 99% chance your portfolio won't lose more than $50 million.

the article goes on to discuss whether the financial blow-out was a result of the VaR not being all it was cracked up to be, or if it was (it was basically a tool formed by a group at j.p. morgan in the early 90s that turned industry standard in a decade.) wall street depending so heavily on this VaR that they lost sight and perspective of this mathematical machines capabilities.

one man called taleb warned against the VaR and the dangerous implications relying on it so heavily could cause. his main criticism is that while you can predict 99% of the time what will happen you have no idea what will happen that 1% of the time, and while that 1% is small it still exists. if there's a 99% chance the most you can lose in one week is $50m that consequently means there's a 1% chance that the least you can lose is $50m.

there's a 99% chance you will live through this week and only get a paper cut. and there's also a 1% chance that a paper cut is the least you'll endure.