Wednesday, December 28, 2011

Pablo Triana Says "Value at Risk" Model Permitted Leverage Up to 1000 to 1

Pablo Triana dates the adoption of the Value at Risk model, internationally, right at the onset of American irrational exuberance after 1994:

Before VaR, which was enshrined into law by international banking regulators around 1996 and finally adopted by the SEC in 2004, the capital charges on toxic trading stuff would have been way less economical for traders, effectively making it unaffordable for banks to bet the entire farm on such dangerous punts. Without VaR, monstrous leverage on balance sheets inundated with high-stakes punts would not have been possible. Many job losses would have been avoided.

Actual capital ratios were so infinitesimal because the model allows debt to take the place of equity.

More here.