Monday, August 13, 2001
The Book of Risk
Dan Borge spent two decades managing risk at Bankers Trust in New York. In this book, he uses his experience in this branch of mathematical statistics to explain the concept of value at risk, VaR, a method for quantifying the chances of disaster striking financial instruments and institutions.
The presentation is intuitive and almost charming in the clarity with which Mr. Borge writes. He goes back to the development of the options pricing model by Harry Markowitz in 1952, a seminal paper in the Journal of Finance that made it possible to abandon intuition for calculation. Mr. Borge, who has a Ph.D. in finance from Harvard and a background in aeronautical engineering at Boeing, writes for folks who don't have an inkling about higher math.
VaR methodology allows an investor to select the stocks in a portfolio that have the highest expected return for any level of risk (standard deviation) one wishes to accept. In practice, this means that one must examine all the intercorrelations among all possible sets of stocks in a portfolio with a given number of stocks. for 100 stocks, that 5,050 standard deviations and correlations.
In corporate management, there are other risks. Mr. Borge discuses credit risk, interest rate risk, credit risk, commodity risk, equity risk, operating risk and liquidity risk all of which can be quantified using the VaR formula. It's all expressed without a single line of differential equations, though interested readers can also refer to Risk Management by Michael Crouhy, Dan Galai, and Robert Mark (McGraw-Hill, 2001), 717 pages, $110.95 CDN, ISBN 0-07-135731-9 to get VaR with no holds barred math.
There has probably never been a simpler or easier to understand explanation of Value at Risk investing and management than Dan Borge's Book of Risk. For the serious investor and manager, it's essential reading.