Assessing Whether Risk Limits Constrain Desk Profitability
Summary
The document discusses how a new risk manager might assess whether VaR, stress-test, and exposure limits are appropriately calibrated and whether they constrain business performance. The suggested approach is to examine which desks or products often approach their limits, review those products’ profitability, and ask profitable desks near their limits whether additional capacity could support more activity. Sector performance can also be compared under alternative limits while keeping overall risk acceptable.
The advice is practical but qualitative: it offers an internal review process rather than a formula for projecting risk measures directly into P&L. It stresses that trader views about needing higher limits should be weighed carefully, since those views may be optimistic. The document gives no empirical results, specific calibration method, or universal threshold for acceptable risk. Its recommendations depend on understanding a firm’s own limits, products, and organization, and it notes that outsiders have little basis for prescribing a solution to a situation this specific.
Key ideas
- Review which desks or products frequently approach their risk limits.
- Compare the profitability of products operating near their limits.
- Ask profitable near-limit desks whether extra risk capacity could support more activity.
- Evaluate changes to limits while keeping total risk within an acceptable range.
- Treat desk requests for higher limits cautiously and account for firm-specific circumstances.
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Full text
# From risk limits to pnl projection? # From risk limits to pnl projection? As a fresh risk manager, today I got an assignment to check whether our risk measurements / limits are setup properly (whether the limits are so tight that affect our p&l) . Better if I can project the values of those measurements to our p&l value. We are mainly interested in three kinds of measurements: the values of VaR, of stress test, and value of exposure. We basically have fixed income products, equities, bond, index and commodity futures, as well as some equity derivatives such as vanilla and exotic options (we are a sell-side firm). So I was wondering if someone can name some articles or share some insight of common practice. Thank you very much! ## Answer by XYQ (score 1) https://quant.stackexchange.com/a/45767 I would check performance return from each sectors and test if it will improve with different risk limit while total risk still tolerable. ## Answer by nbbo2 (score 1) https://quant.stackexchange.com/a/45768 Seems like a complicated issue perhaps not well suited for general discussion (too specific to the situation). What I would do is (0) Understand in detail what the limits are currently (may be trivial or may involve a lot of questioning and writing things up on your part) (1) Check which product desks are frequently at or near their upper limits (2) Check the profitability of such products (3) Inquire with profitable near-the limit desks whether they could use a bigger limit, keeping in mind however that traders almost always feel that they could be much more successful if they had bigger limits :) In any case it is an excellent project for you to learn more about the internal functioning of your organization and meet people with different jobs and points of view. But the advice outsiders can give you is limited.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.