JP Morgan, VaR, and my Parking Ticket: or VaR for the Rest of Us

May 25, 2012 Attain Capital 1 Comment  Like
Off Topic

The concept Var (Value at Risk) has been all over the news the past few weeks after JP Morgan announced it had lost $2 Billion on a trade, partially as a result of their VaR model miscalculating things. We even covered it here. But how many of us really understand what VaR is? Is there a real-world example for the rest of us? We think we might have one…

Last night, we had the opportunity to take several clients from Spain out to dinner. The 9 PM reservation was early for our Spaniard friends, if late for us. As an aside, we took our guests from Spain to an Italian restaurant in an area of Chicago called Ukrainian Village, but that’s a topic for another time. Anyway, we drove to dinner, and found a parking spot half a block away from the restaurant. Bingo.

Now, parking in Chicago works on a pay box system, where you put a credit card into the machine and get a small voucher/ticket to place in your window. Parking is enforced up until 9pm, at which point no voucher is needed.  We pulled into the parking spot at 8:52 PM, and would have required a $0.25 or so payment to be in the spot for the next 8 minutes, after which the spot was free.

But, being folks who don’t shy away from risk, a little voice inside our heads was suddenly saying – there’s no way they are going to be checking windshields in this neighborhood for paid parking vouchers in the 8 remaining minutes until 9 PM – save your $0.25.

And thus, right there on Chicago Ave. at 8 minutes to 9 PM, we did a quick Value at Risk calculation. The internal risk model was telling us there was essentially a 0% chance of having to spend any money for that parking space – or, in VaR parlance, we had a 99.99% confidence level that we would not lose more than the $0.25 we were “earning” by not buying the voucher. So, we put on the “trade,” risking $50 to make $0.25, getting no voucher and headed into dinner.

You know where this story is going. At 10:45 or so, we came out of the restaurant to find a ticket on the car. That’s right – surprise, surprise – the true odds of someone checking windshields in the last 8 minutes of the night were actually a bit higher than we had calculated. The VaR model had failed, and we ended up losing 200 times what we tried to earn – losing $50 because we thought we had a 100% chance of making $0.25.

Now, if this were an exact analogy, we probably would not have the $50 to cover the parking ticket (despite having “earned” the $0.25 thousands of times before without a ticket), and would have had to be “bailed out” by a friend who loaned us the money at essentially 0% with no timetable to repay.

This is what is happening at the too big to fail banks. They are risking many times what they hope to gain based on the logic that there is a 99% chance they won’t lose what they are risking. But just like the parking attendant happening upon the car in the last few minutes of the night, the thing that isn’t supposed to happen ends up happening a bit more frequently than the statistics tell us it should – causing losses they usually aren’t prepared to handle.

One comment

  1. Hedger
    June 5, 2012

    6 Sigma would have alerted you that the risk was high.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The programs listed here are a sub-set of the full list of programs able to be accessed by subscribing to the database and reflect programs we currently work with and/or are more familiar with.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history. Individuals cannot invest in the index itself, and actual rates of return may be significantly different and more volatile than those of the index.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

Limitations on RCM Quintile + Star Rankings

The Quintile Rankings and RCM Star Rankings shown here are provided for informational purposes only. RCM does not guarantee the accuracy, timeliness or completeness of this information. The ranking methodology is proprietary and the results have not been audited or verified by an independent third party. Some CTAs may employ trading programs or strategies that are riskier than others. CTAs may manage customer accounts differently than their model results shown or make different trades in actual customer accounts versus their own accounts. Different CTAs are subject to different market conditions and risks that can significantly impact actual results. RCM and its affiliates receive compensation from some of the rated CTAs. Investors should perform their own due diligence before investing with any CTA. This ranking information should not be the sole basis for any investment decision.

See the full terms of use and risk disclaimer here.

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