Editing Value at risk (section)

== History ==

The problem of risk measurement is an old one in [[statistics]], [[economics]] and [[finance]]. Financial risk management has been a concern of regulators and financial executives for a long time as well. Retrospective analysis has found some VaR-like concepts in this history. But VaR did not emerge as a distinct concept until the late 1980s. The triggering event was the stock market [[Black Monday (1987)|crash of 1987]]. This was the first major financial crisis in which a lot of academically-trained [[Quantitative analyst|quants]] were in high enough positions to worry about firm-wide survival.<ref name="Jorion" />

The crash was so unlikely given standard [[statistical]] models, that it called the entire basis of [[Quantitative analyst|quant]] finance into question. A reconsideration of history led some quants to decide there were recurring crises, about one or two per decade, that overwhelmed the statistical assumptions embedded in models used for [[Trader (finance)|trading]], [[investment management]] and [[Derivative (finance)|derivative]] pricing. These affected many markets at once, including ones that were usually not [[Financial correlation|correlated]], and seldom had discernible economic cause or warning (although after-the-fact explanations were plentiful).<ref name="Roundtable II" /> Much later, they were named "[[Black Swan theory|Black Swans]]" by [[Nassim Nicholas Taleb|Nassim Taleb]] and the concept extended far beyond [[finance]].<ref name="Black Swan">{{cite book | author=Taleb, Nassim Nicholas | title=The Black Swan: The Impact of the Highly Improbable | publisher=[[Random House]] | location=New York | year=2007 | isbn=978-1-4000-6351-2| title-link=The Black Swan: The Impact of the Highly Improbable }}</ref>

If these events were included in [[quantitative analysis (finance)|quantitative analysis]] they dominated results and led to strategies that did not work day to day. If these events were excluded, the profits made in between "Black Swans" could be much smaller than the losses suffered in the crisis. Institutions could fail as a result.<ref name="Einhorn I" /><ref name="Roundtable II" /><ref name="Black Swan" />

VaR was developed as a systematic way to segregate extreme events, which are studied qualitatively over long-term history and broad market events, from everyday price movements, which are studied quantitatively using short-term data in specific markets. It was hoped that "Black Swans" would be preceded by increases in estimated VaR or increased frequency of VaR breaks, in at least some markets. The extent to which this has proven to be true is controversial.<ref name="Roundtable II" />

Abnormal markets and trading were excluded from the VaR estimate in order to make it observable.<ref name="Haug">{{cite book|author=Espen Haug|title=Derivative Models on Models|publisher=John Wiley & Sons|year=2007|isbn=978-0-470-01322-9}}</ref> It is not always possible to define loss if, for example, markets are closed as after [[September 11 attacks|9/11]], or severely illiquid, as happened several times in 2008.<ref name="Einhorn I" /> Losses can also be hard to define if the risk-bearing institution fails or breaks up.<ref name="Haug" /> A measure that depends on traders taking certain actions, and avoiding other actions, can lead to [[self reference]].<ref name="Jorion" />

This is risk management VaR. It was well established in [[Quantitative analyst|quantitative trading]] groups at several financial institutions, notably [[Bankers Trust]], before 1990, although neither the name nor the definition had been standardized. There was no effort to aggregate VaRs across trading desks.<ref name="Roundtable II" />

The financial events of the early 1990s found many firms in trouble because the same underlying bet had been made at many places in the firm, in non-obvious ways. Since many trading desks already computed risk management VaR, and it was the only common risk measure that could be both defined for all businesses and aggregated without strong assumptions, it was the natural choice for reporting firmwide risk. [[JPMorgan Chase|J. P. Morgan]] CEO [[Dennis Weatherstone]] famously called for a "4:15 report" that combined all firm [[risk]] on one page, available within 15 minutes of the market close.<ref name="Roundtable I" />

Risk measurement VaR was developed for this purpose. Development was most extensive at [[JPMorgan Chase|J. P. Morgan]], which published the methodology and gave free access to estimates of the necessary underlying parameters in 1994. This was the first time VaR had been exposed beyond a relatively small group of [[Quantitative analyst|quants]]. Two years later, the methodology was spun off into an independent for-profit business now part of RiskMetrics Group (now part of [[MSCI]]).<ref name="Roundtable I" />

In 1997, the [[U.S. Securities and Exchange Commission]] ruled that public corporations must disclose quantitative information about their [[Derivative (finance)|derivatives]] activity. Major [[bank]]s and dealers chose to implement the rule by including VaR information in the notes to their [[financial statements]].<ref name="Jorion" />

Worldwide adoption of the [[Basel II Accord]], beginning in 1999 and nearing completion today, gave further impetus to the use of VaR. VaR is the preferred [[Measure (mathematics)|measure]] of [[market risk]], and concepts similar to VaR are used in other parts of the accord.<ref name="Jorion" />