VaR has established itself as a ubiquitous risk management tool for more than a decade. Yet, it looks far from perfect.

Fund managers, bankers, risk managers and the whole world of finance had sighed in relief when J P Morgan came up with a new risk measurement model `Value at Risk' (VaR), in the mid-90s. Quantifying risks has never been as simple as quantifying returns. Finance executives, therefore, fell in love with VaR and till today it remains strong. Hedge funds and regulators are the latest adopters of VaR. The traditional measures of risk are mostly volatility-based, which never spew out a dollar figure of loss in the worst case scenario like VaR. The result was that VaR became as ubiquitous for portfolio risk management, as perhaps EPS and P/E are for stocks.

The Bank for International Settlements (BIS), the international body that prescribes prudential measures for banks worldwide, has prescribed VaR as a risk measurement tool to be used by financial institutions in its Basel II norms. Since many banks are already using VaR, they have greeted the change with three cheers. It perhaps will not be an exaggeration to say that the world of finance today swears by VaR, to minimize the magnitude of losses they might incur.

After a decade of honeymooning with VaR, finance executives are beginning to realize VaRs' limitations. If the research studies about the usefulness of VaR are any indication, one wonders whether the tool which is designed to minimize risk, is actually increasing it.