No VaR of the Jungle? Dangerous Creatures May Enter the Village

For the last weeks Andreas has been quite actively writing the posts below on the city swap. An example of a financial deal, that accumulated all possible misunderstandings between a seller (the Bank) and a buyer (the City). The deal is now disputed at the court.

There is no need to have rocket science modelling for analysing the riskiness of the specific swap:

We Valuate THE Swap on February 5
A Short History of Floating Rates
Getting Numbers For the Swap
The Future Development of Exchange Rates
Garman Kohlhagen Analyzed
FX Option Values Under Garman Kohlhagen
VaR and Expected Shortfall for Managing the FX Swap
VaR and ES - The City Swap
The City Swap Conclusions

In VaR of the Jungle I have taken Aaron Brown's metaphor: VaR is like a fence built around the Village in the JungleThe fence is built in a relatively safe place, and remaining dangers inside are cleared out. But people spend, say, 5% of their time outside the fence where dangers are greater and less known. 

But how great? How less known? If your VaR based risk analysis tells you, the danger is horrible: don't build the village in the jungle.

The no-problem problem

The essence of risk management: expose the risk in order to decide the adequate measure immediately and not when it eventually happened. Such a measure can be building the fence, ….. or not erecting the village.

But if you live in the false comfort that you know the conditions it becomes horrible, when the giant dangerous creatures with their saber teeth materialize …

Usually there are no problems in boom times.

Picture from sehfelder