a significant change in the behaviour of investors for some time. ( iv ) value at risk ( var ) most financial firms use var and stress tests to measure market risks and assign position limits. despite declining financial market volatility during recent years, most large banks have nevertheless reported a trend rise in the aggregate var of their trading book. this presumably implies that they have taken larger positions. this is not necessarily a matter of concern because trading profits and capital increased broadly in line with higher vars. yet the marked movements in the absolute vars of large firms over time does raise questions. these changes could reflect : ( a ) underlying market volatility ; ( b ) frequent changes in the firm ’ s positioning ; or ( c ) changes in various aspects of methodology. if firms, conscious of methodological shortcomings, frequently modify how they compute their vars, changes over time may not be a good guide to changes in underlying risk exposures. this would also make it harder for counterparties to keep accurate track of how underlying risks are evolving. ( v ) stress tests stress tests used by banks probably do not adequately reflect their substantial reliance on liquid capital and money markets for managing, distributing and hedging risks. some of the problems ( eg., difficulties in the leveraged loan market, the valuation of complex products ) are not typically incorporated in stress tests. stress tests at many banks also may fail to adequately capture the potentially significant growth in balance sheet exposures resulting from contingent credit and liquidity facilities to abcp conduits. moreover, stress tests tend to focus on a few risks and thus often fail to capture the potential interactions between many different risk factors. and in such stress tests, banks frequently assume an ability to unwind positions across a wide range of asset classes – including structured credit and other complex products – that may not be feasible in stressed conditions. in addition, attempts to reduce risk exposures during a credit event can further impair market liquidity. this failure to take into consideration the likelihood that leveraged firms ( during a period of market stress ) would attempt to reduce exposures in virtually identical ways might explain why large financial shocks have been more frequent during the past 10 years than models predicted – even as underlying macroeconomic conditions have become more stable. it is thus clear that recent bouts of market uncertainty have been aggravated by the lack of information about the distribution of risks in the global financial system and the risk profiles of individual institutions. new, complex financial instruments have

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