VaR

Here's an excellent article by Joe Nocera on the role Value at Risk (VaR) played in the current financial crisis. It is like a story on VaR.

"In peacetime, you think about other people’s intentions. In wartime, only their capabilities matter. VaR is a peacetime statistic.

The big problem was that it turned out that VaR could be gamed....To motivate managers, the banks began to compensate them not just for making big profits but also for making profits with low risks. That sounds good in principle, but managers began to manipulate the VaR by loading up on what Guldimann calls “asymmetric risk positions.” These are products or contracts that, in general, generate small gains and very rarely have losses. But when they do have losses, they are huge. These positions made a manager’s VaR look good because VaR ignored the slim likelihood of giant losses, which could only come about in the event of a true catastrophe."