His work was
published in 1921.
Guided by VAR models, a change in volatility allows a bank or a hedge
fund to increase or decrease assets with the same risk level and thus
exacerbate the overall hazard of a portfolio. The collapse of the
star-studded Long Term Capital Management (LTCM) hedge fund in 1998 is
partly attributable to this misconception.
In the Risk annual congress in Boston two years ago, Myron Scholes of
Black-Scholes fame and LTCM infamy, publicly recanted, admitting that,
as quoted by Dwight Cass in the May 2002 issue of Risk Magazine: "It is
impossible to fully account for risk in a fluid, chaotic world full of
hidden feedback mechanisms." Jeff Skilling of Enron publicly begged to
disagree with him.
Last month, in the Paris congress, Douglas Breeden, dean of Duke
University's Fuqua School of Business, warned that - to quote from the
same issue of Risk Magazine:
" 'Estimation risk' plagues even the best-designed risk management
system. Firms must estimate risk and return parameters such as means,
betas, durations, volatilities and convexities, and the estimates are
subject to error. Breeden illustrated his point by showing how
different dealers publish significantly different prepayment forecasts
and option-adjusted spreads on mortgage-backed securities .
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