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Enron Mail |
I completely agree with you.
Nevertheless, I am sorry if I did not make myself clear when we talked about this last Tuesday: I am not advocating penalizing business units because of their 1week ROVARs or Sharpes. I would certainly not set traders' bonuses based on these numbers (nor do I think anyone at Enron would consider doing that). Enron focuses on long term profit and risk. However, the long term is made up of many short terms, and catastrophes can occur if a company's management does not pay close attention to the latter. Indeed, Enron management is very interested in short term profitability (they want to be notified of very large 1 and 5 day losses) and short term risk (we report daily VaR limit violations). In this spirit, I am simply offering 1 and 4 week ROVARs and Sharpes as something interesting and useful that we can now produce from the DPR database, and I will let upper management use or ignore them as they see fit. Regards, Eugenio Naveen Andrews@ENRON 09/08/2000 11:13 AM To: Eugenio Perez/HOU/ECT@ECT cc: Ted Murphy/HOU/ECT@ECT Subject: Risk Metrics Eugenio, In regard to your recent e-mail concerning RoVar, Sharpe and other risk metrics, and our meeting on Tuesday, it is imperative to understand that (1) While P&L is a number one can aggregate on a daily basis, VaR numbers on 1-week or 4-week basis, and consequently RoVaR numbers, are not meaningful operationally (ie, trading activity and senior management decision-making) and statistically. RoVaR and Sharpe were designed to measure business unit performance over extended time periods (preferably a year). Specifically, you cannot penalize, or make reasonable business decisions about a unit , because of their 1-week RoVar or Sharpe. (2) Significant trading activity at ENE is composed of long-term strategic trades (seasonal plays with durations of over 6 months, perhaps), wherein desk heads and senior management have an intuitive feeling for their RoVaR (OVER 6 MONTHS). A 1-week or 4-week "interim" number in this case is not useful. Traders might purposefully want to make a certain 1-week or 4-week RoVaR LOW in their trading activity if they believe their 6-month number can be HIGH. In such a case, a 1-week number might send dangerous messages to senior management. (3) Conceptually, P&L and VaR, in isolation, are numbers which are sound and rigourously calculated. The Ratio, however, one has to be careful about. The numerator (cumulative P&L over a certain period) can be aggregated by simple arithmetic summation, no problems. However, the denominator (average daily VaR over a certain period) relies on the underlying assumption that each point in your time series is independent and correlationless. To get a sufficient statistic for the denominator, one would have to take a large sample in your series (6 months or more), for a DAILY AVERAGE VaR number to be meaningful, statistically. (4) The RAC group has instituted similar metrics which have been in usage for over two years. The numbers are shown to the B.O.D with the express intent of comaring business unit performance on a 6-month or yearly tenor. Please contact Matthew Adams (RAC) or myself to make sure that we are on the same footing regarding the actual calculation of such metrics. Also, in the future, just to be consistent and on-the-same-page, please contact me or Mr. Adams if any risk-related numbers are to be showcased in a public forum. (5) Finally, as you can probably corroborate, senior management might not be fully versed on the nuances of VaR, let alone 1-week VaR ratios. Therefore, one has to be wary of the misuse of ratios and risk metrics. I liked your presentation of your database on Tuesday. I think it is a nice step in aggregating and dissecting P&L from disparate sources. Best Regards Naveen
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