An Overview of Value at Risk Darrell Duffie and Jun Pan
Preliminary Draft:
January 217 1997
This reviewl of value at risk, or "VaR.’’ describes some of the basic issues involved
in measuring the market risk of a financial firm7s "book,” the list of positions in vari-
ous instruments that expose the firm to financial risk. While there are many sources
of financial risk, we concentrate here on market risk, meaning the risk of unexpected
changes in prices or rates. Credit risk should be viewed as one component of market
risk. We nevertheless focus narrowly here on the market risk associated with changes
in the prices or rates of underlying traded instruments over short time horizons. This
would include, for example, the risk of changes in the spreads of publicly traded corpo-
rate and sovereign bonds, but would not include the risk of default of a counterparty on
lDarrell Duffie and Jun Pan are at The Graduate School of Business, Stanford University, Stanford
CA 94305-5015, USA. Telephone: 415-723-1976. Our email addresses are duffie@baht . stanford. edu
and junpan@ecu. stanford.edu, respectively. Please do not copy without permission of the authors.
This review owes much in its design and contents to many conversations with Ken Froot of Harvard
Business School, Joe Langsam of Morgan Stanley, and Ken Singleton of Stanford University. They
should not be held responsible for errors, and our opinions do not necessarily coincide. We are also
grateful for the editorial guidance of Stephen Figlewski and financial support from the Financial Re-
search Initiative at the Graduate School of Business, Stanford University. We are grateful for research
assistance by Yaroslaw Bazaily, Qiang Dai, Eugene Demler, Mark Ferguson, and Tom Varner, and
for conversations with Mark Williams and Wei Shi of Bank of America; Jim Cogill, David Dougherty,
Anurag Saksena, Dieter Dorp, and Fred Shin of The Royal Bank of Canada; Vince Kaminsky and
Matthew Verghese of Enron Capital and Trade Resources; Robert Litterman of Goldman Sachs; Andy
Morton and Dexter Senft of Lehman Brothers; Steve Benardete, Robin Brenner, Steve Brauer, Adam
Duff, Craig Gustaffson, Joe Langsam, and Patrick De Saint-Aignan of Morgan Stanley and Company;
Matt Page of Susquehanna Investment Group; Dan Mudge of Banker;s Trust; Arturo Estrella of The
Federal Reserve Bank of New York; and Peter Glynn of Stanford University.
|