An Introduction to Value-At-Risk, Fourth Edition

Chapter 1

INTRODUCTION TO RISK

The risk management department was one of the fastest growing areas in investment and commercial banks during the 1990s. A string of high-profile banking losses and failures, typified by the fall of Barings Bank in 1995, highlighted the importance of risk management to bank managers and shareholders alike. In response to the volatile and complex nature of risks that they were exposed to, banks set up specialist risk management departments, whose functions included both measuring and managing risk. As a value-added function, risk management can assist banks not only in managing risk, but also in understanding the nature of their profit and loss, and so help increase return on capital. It is now accepted that senior directors of banks need to be thoroughly familiar with the concept of risk management. One of the primary tools of the risk manager is value-at-risk (VaR), which is a quantitative measure of the risk exposure of an institution. For a while VaR was regarded as some-what inaccessible, and only the preserve of mathematicians and quantitative analysts. Although VaR is indeed based on statistical techniques that may be difficult to grasp for the layman, its basic premise can be explained in straightforward fashion, in a way that enables non-academics to become comfortable with the concept. Later in the book we describe and explain the calculation ...