Value-at-risk quantifies portfolio exposure through estimated loss probabilities.

Evidence

The risks involved in LTCM’s positions were carefully calculated and controlled using the “value-at-risk” approach, a standard practice of the world’s leading banks (Meriwether interview). Value-at-risk is a measure of the exposure of a portfolio to adverse price movements. In the case of the dollar swap spread, for example, historical statistics and judgments of likely future values led LTCM to estimate that the spread had an “equilibrium value” of around 30 basis points, with a standard deviation of about 15 basis points per annum (Rosenfeld interview; a “basis point” is a hundredth of a percentage point). Using those estimates, it was then possible to work out the relationship between the magnitude of possible losses and their probabilities, and thus to work out the value-at-risk in the trade. — Donald MacKenzie, An Engine, Not a Camera, 995

Categorization

• DEFINE: Defines value-at-risk and basis point as the risk-management frame that later failed at LTCM.
• XREF: connects to: The bell-curve shape of Gaussian distributions is what banks’ risk models assume; Financialization treats risk as probabilisable, displacing close knowledge of the object valued — Ève Chiapello, Financialisation of Valuation, 35; Probabilistic valuation methods migrated from actuarial science into financial markets via Gaussian risk models — Ève Chiapello, Financialisation of Valuation, 33 (+4 more)