GARP meeting observations

I have decided to write my blog posts more often. In the past I have started writing long and thoughtful pieces. Then they sit unfinished on my desktop waiting for me to get back to them. I will now write shorter posts on ideas that strike me as insightful and spend less time editing them for perfection.

If you are a risk manager or want some insight on evaluating your firm's risk vs reward balance, The New York City chapter of GARP the Global Association of Risk Professionals holds monthly meetings that are interesting, easy to digest and not overly technical. The theme of the September 24th meeting was how did China come out of the financial crisis and what financial muscle will they flex now. China has a different and mostly separate financial system. Our financial system just had a major shakeout, China's didn't. As several of the presenters spend their professional lives doing business with China, one can forgive them for spending a bit too much time stating the obvious as revelation.

There were a number of takeaway conclusions from the evening. The most glaring is China's inevitable shakeout and restructuring is some years in the future. The birds are singing even more loudly in the trees than even last year. China has the world's largest sovereign wealth fund. Conclusion, the government has all the money and the people are mostly still poor. The Chinese market generates the best risk adjusted returns in the world. Conclusion, historical time horizon is way too short. The market in China consistently under prices risk.

All risk models work. The ones that work the best are widely adopted. The greater the adoption rate, the more the model itself affects the market and the bigger the break when it fails. Don't take models too seriously. They attempt to describe possible realities but they are not themselves reality. With good models you can still go out of business. It is always prudent to take models with a grain of salt.

When markets crash the only thing that goes up are correlations. VaR estimations that incorporate the benefits of hedging are likely to be wildly optimistic.

With the elimination of fixed commissions, the only way to make money in trading markets is huge volumes on narrow spreads or lower volumes with wide spreads. Huge volume trade strategies are particularly vulnerable to liquidity traps. Wide spread markets rely on pricing and valuation opacity. Opaque markets are increasingly under attack from burned customers and will become more difficult to create going forward.

I sensed a general frustration with managers latching onto VaR as the one metric answer to describe a firm's or portfolio's market risk. Presenting a single value rarely conveys much information. Managers know this but often do not have the vocabulary to describe risks to their superiors or ask appropriate questions to the presenters. As a result, risk managers have been left feeling their warnings are not being heard. The problem is less technical than it is psychological. Listeners want to hear the bottom line and people who are good with mathematical models often have difficulty properly communicating the limitations of their analysis to decision makers. This problem is not going to get better as long as companies hire and promote technical specialists rather than more articulate multi talented individuals.