Research 2.0

Sunday, June 04, 2006

Bank of France warns on risk....

The FT carried the story on May 31, 2006 that the "Bank of France warned that the tools used to measure risk had been made obsolete by the rapid growth of complex financial products, such as credit derivatives and structured investements in hedge funds."

The article goes on to emphasize what the BoF was most concerned about the "value at risk" computation which could be much lower than the actual risk if market volatility and/or interest rates increase.

Interesting the "value at risk" measure which is the item most investors focus on assumes that positions can be liquidated in 10 days. Beyond being just arbitrary this assumption seems quite inconsistent with what can reasonably be expected in the market today, let alone a panicked market where liquidity is severely tested by hurding market participants!

In a related article JPMorgan noted that the amount of funds invested in the collateralised debt obligation (CDO) market is now about $1 trillion and may reach or even exceed the $1.2 trillion estimated for the hedge fund industry.

Another chapter in our continuing exploration of systemic risk in the global financial system.