How To Get Permission To Put $2 Billion Of Your Employer's Money At Risk (UBS)

To better understand why, you must understand value-at-risk, or VaR.

VaR is one of the most common ways to measure how much money a bank has at risk.  In a nutshell, VaR is the maximum amount of money one could lose over a certain period of time given a certain level of confidence.

For example, if you had a one day VaR of $100 at a 95% level of confidence, then there is a 95% chance you won't lose more than $100 in one day.

However, this doesn't mean that the worst-case-scenario loss in a given day is capped at $100.  In fact, thanks to the existence of derivatives and the ability to short, the maximum loss for a trading department can be unknown. Such weaknesses have drawn criticism from the likes of hedge fund manager David Einhorn and The Black Swan author Nassim Taleb, who calls VaR a "fraud."

So, now we have framework in which to think about UBS' $2 billion loss.

DealBreaker's Matt Levine did some digging and found that the UBS investment bank's maximum one day VaR at a 95% confidence level was 98 million Swiss francs, or around $113 million, at the end of the second quarter.

After crunching the numbers, Levine concluded that losing $2 billion would've been a 29 standard deviation event, effectively a statistical impossibility.

So, here's one way the whole UBS' trade might've gone down: Kweku Adoboli comes into work one day and goes to his manager with a trade idea.  He presents a couple of negative scenarios including one absolutely insane scenario just for kicks.  "Boss, there's a chance I might lose $2 billion dollars on this trade.  But that would be a 29 standard deviation event, which means I'm more likely to get struck by lightning while riding on the back of a flying pig!"  Both laugh and Adoboli gets the go-ahead.

View the original article here

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