Arigata-meiwaku
is a Japanese word with no English equivalent. Which is not surprising, since
it means: “an act someone does for you that you didn’t want to have them do
and tried to avoid having them do, but they went ahead and did it anyway,
determined to do you a favour. Then things went wrong and caused you a lot of
trouble; yet in the end social convention obliged you to say Thank you”.
is a Japanese word with no English equivalent. Which is not surprising, since
it means: “an act someone does for you that you didn’t want to have them do
and tried to avoid having them do, but they went ahead and did it anyway,
determined to do you a favour. Then things went wrong and caused you a lot of
trouble; yet in the end social convention obliged you to say Thank you”.
In the last few days, the commonly-used risk
measurement, Value at Risk, (or VaR) has been given stick
for performing arigata-meiwaku (or some variant of it) for JP Morgan’s loss-making credit
derivatives special ops team (aka the Chief Investment Office).
measurement, Value at Risk, (or VaR) has been given stick
for performing arigata-meiwaku (or some variant of it) for JP Morgan’s loss-making credit
derivatives special ops team (aka the Chief Investment Office).
Here goes:
The
pundits are dissing VaR generally for not doing its
job properly; namely, failing to sound the alarm at JP Morgan to warn of an
impending mega-hit of circa GBP 4 Billion in its credit derivatives portfolio, when in reality it was
never VaR’s job to work out whether JP Morgan could readily unwind its enormous
and concentrated credit derivative positions and, if it couldn’t, then
how much it would actually end up costing to unwind them in a highly nervous market
which has just watched the painstakingly-negotiated Franco-Germanic austerity
agreement, designed to stabilise Europe, getting unceremoniously ripped up by a new
French presidential wildcard who then got vocal support from President Obama (Thanks, Big Guy) even as Greece prepares
to vote on whether to abandon the Euro and, in effect, push Europe’s
financial markets a few kilometres further towards the abyss!
pundits are dissing VaR generally for not doing its
job properly; namely, failing to sound the alarm at JP Morgan to warn of an
impending mega-hit of circa GBP 4 Billion in its credit derivatives portfolio, when in reality it was
never VaR’s job to work out whether JP Morgan could readily unwind its enormous
and concentrated credit derivative positions and, if it couldn’t, then
how much it would actually end up costing to unwind them in a highly nervous market
which has just watched the painstakingly-negotiated Franco-Germanic austerity
agreement, designed to stabilise Europe, getting unceremoniously ripped up by a new
French presidential wildcard who then got vocal support from President Obama (Thanks, Big Guy) even as Greece prepares
to vote on whether to abandon the Euro and, in effect, push Europe’s
financial markets a few kilometres further towards the abyss!
Stay with me.
In those periods
when history faithfully repeats itself, VaR is pretty good at predicting the
severity of loss you might reasonably expect to suffer in your investments
portfolio (at some given level of probability).
when history faithfully repeats itself, VaR is pretty good at predicting the
severity of loss you might reasonably expect to suffer in your investments
portfolio (at some given level of probability).
However, at times
when history is pretty far from about to faithfully repeat itself (like right
around now) and you have a huge illiquid set of credit-linked positions, VaR is
really just doing you a favour and taking a stab in the dark on the size and arrival times of various industrial goods freight trains you should expect to come down the rail
tracks across which you have tied yourself.
when history is pretty far from about to faithfully repeat itself (like right
around now) and you have a huge illiquid set of credit-linked positions, VaR is
really just doing you a favour and taking a stab in the dark on the size and arrival times of various industrial goods freight trains you should expect to come down the rail
tracks across which you have tied yourself.
In fact, if you are
a bank running a gigantic portfolio of concentrated credit derivatives in a
wafer-thin market, VaR has very little interest in getting involved at all in
your gig, and would much prefer that you use a couple of its sister risk
measures, including the gorgeous, but brutally candid, “Scenario Testing”.
a bank running a gigantic portfolio of concentrated credit derivatives in a
wafer-thin market, VaR has very little interest in getting involved at all in
your gig, and would much prefer that you use a couple of its sister risk
measures, including the gorgeous, but brutally candid, “Scenario Testing”.
Scenario Testing is
a What You See Is What You Get risk
measure that doesn’t attempt to work out what is likely to happen on the
basis of a complex statistical algorithm based on historical data. In other
words, where VaR is stochastic,
Scenario Testing is deterministic.
It knows that in this fickle, crazy, messed up world economy we now find
ourselves living in, it is close to pointless to attempt to calculate the
difficulty (and, therefore, the expense) of unwinding your ocean-going credit
derivatives portfolio in a hurry. So it doesn’t even go there.
a What You See Is What You Get risk
measure that doesn’t attempt to work out what is likely to happen on the
basis of a complex statistical algorithm based on historical data. In other
words, where VaR is stochastic,
Scenario Testing is deterministic.
It knows that in this fickle, crazy, messed up world economy we now find
ourselves living in, it is close to pointless to attempt to calculate the
difficulty (and, therefore, the expense) of unwinding your ocean-going credit
derivatives portfolio in a hurry. So it doesn’t even go there.
Scenario Testing
simply stresses market conditions to the max and says:
Let’s
assume the
market has discovered that you have sold protection the size of Alaska on
an illiquid credit derivatives index (the CDX
IG Series 9), and let’s also assume the market really doesn’t want to help
you unwind your entire “bespoke” derivatives collection next Tuesday. In that
super-stressed, low liquidity, Land of Mordor scenario, this is how much it
would actually cost to close out your positions. Now, can you take that kind of
pain? If not, don’t assemble that kind of portfolio!
assume the
market has discovered that you have sold protection the size of Alaska on
an illiquid credit derivatives index (the CDX
IG Series 9), and let’s also assume the market really doesn’t want to help
you unwind your entire “bespoke” derivatives collection next Tuesday. In that
super-stressed, low liquidity, Land of Mordor scenario, this is how much it
would actually cost to close out your positions. Now, can you take that kind of
pain? If not, don’t assemble that kind of portfolio!
Given the size and
nature of its credit derivative positions, and given current adverse market
conditions, that is the measure JP Morgan should have used to monitor and
manage its risk. Maybe it did do some Scenario Testing, but maybe, also,
it ignored the results until, eventually, the tempest
grew too big for the teacup. Who knows?
VaR has its
well-documented shortcomings, for sure, but on this occasion it must be rueing
the day it ever agreed to dance the arigata-meiwaku. Things have gone wrong and caused a lot of trouble. And no-one is saying Thank you.
well-documented shortcomings, for sure, but on this occasion it must be rueing
the day it ever agreed to dance the arigata-meiwaku. Things have gone wrong and caused a lot of trouble. And no-one is saying Thank you.
PS: Another genius
word from the Japanese lexicon:
word from the Japanese lexicon:
Age-otori (verb): “to look worse following a haircut”.
Now, fancy that! A
Japanese word coined specially to describe Greece.
Japanese word coined specially to describe Greece.
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