Quantitative Risk Management: A Practical Guide to Financial Risk, + Website

Chapter 6

Uses and Limitations of Quantitative Techniques

We have now finished our examination of Risk Management: how we should think about risk, the proper role of management within risk management, and some of the intuition behind the numbers. In the following chapters we turn to Quantitative Risk Measurement; we tackle the mathematics and the technical details. What is the definition of volatility and VaR, what is the contribution to volatility, how do we handle fat tails? We need to get these details right. That is not to say we always need the perfect answer—an approximation that tells us 90 percent of the answer today is better than the perfect answer that arrives too late. But we do need to be careful, understanding the technical details well enough to separate wheat from chaff and apply reasoned judgment and common sense to the technical details.

I hope the following chapters are valuable to a wide range of readers. They are, of course, primarily aimed at quantitative users whose job it is to understand and produce the numbers. But I do not want to dissuade less-technical readers from perusing some of the chapters. I have tried to provide the intuition behind the mathematics at the same time as giving the formulae. I have illustrated many of the quantitative tools with examples, particularly in Chapters 9 and 10, and these should be accessible to all readers.

Before turning to the technical chapters, however, it is worthwhile to review some of the limitations of quantitative ...