VaR's usefulness, he concludes, lies more in the processes and systems it encourages than in the substance of the single number it provides. D iscussions of financial risk can bring to mind the story of the six blind men describing an elephant. One man feels the trunk and concludes the elephant is like a snake. Another touches a leg and likens the beast to a tree. Each of the blind men manages to state something strictly correct yet none of their descriptions fully captures all aspects of the creature.
Financial risk is at least as difficult to summarise as an elephant.
Yet, we are rarely able to give a complete picture of one of the most fundamental drivers of economic behaviour. The quest has been championed by regulatory bodies, aided by a string of well-publicised financial disasters, fed by a growing software and consulting industry and widely embraced by the financial companies and corporations exposed to the risk everyone is trying to measure. Put succintly, it is a percentile of a profit and loss distribution over a specified horizon. To give some life to that definition, let us consider an example. We fix a time horizon over which to consider the risk - two weeks, for example.