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Eating Our Own Cooking
Jun 1, 2005
In this month's research note, we attempt to follow some of our advice from last month, that Value-at-Risk exceptions should be diagnosed and explained. The upheaval in structured credit derivatives in May gave us noteble exceptions to our Value-at-Risk forecasts. We look to diagnose one problematic trade -- a first loss index tranche hedged by another tranche on the same index. We describe and motivate the trade, and then argue that though there is room for improvement in the assessment of risk on such positions, there was probably little we could have done with a historically based model to capture May's events. We argue instead that market expertise and an understanding of the motivation for the trade may have given us some insight to stress tests for the position.
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