Value at risk is a risk management tool that is not exempt from limitations, including, for instance, the fact that the size of losses beyond VaR is not taken into consideration, and its nonsubadditivity, i.e., the fact that in certain circumstances the VaR of a portfolio can be higher than the sum of the individual VaR values of its constituents. Nevertheless, VaR can be an extremely important tool for improving the quality of a bank s risk management processes, since it is potentially able to compare different risks under a similar metric, to support bank decisions concerning the optimal amount of capital the bank should hold, and to help the bank understand better its profitability in risk-adjusted terms.

Developing a risk management system is in any case a complex task that requires coordinated investments in many different areas: methodologies, databases and information technology infrastructure, internal processes, people, and risk management culture. Developing state-of-the-art methodologies can, of course, be important, and efforts to check and improve their effectiveness should be constant. At the same time, budget constraints and data availability always require accepting some compromises. Databases and IT infrastructure are particularly important since the former are a key condition for developing and applying sophisticated methodologies, while the IT infrastructure must ensure that data used by the risk management system are consistent, aligned with front and middle office data, and properly stored to allow subsequent analyses, while risk management outputs must be readily available wherever necessary throughout the bank.

Throughout the book we...