RiskMetrics

Explained:

RiskMetrics was a free service offered by JP Morgan in 1994 to promote value-at-risk (VaR) as a risk management tool. At the time, VaR was used by some financial firms but was largely unheard of among corporate treasuries, energy firms and commodity trading firms. RiskMetrics was one of three factors that lead to widespread adoption of value-at-risk by both financial and non-financial firms during the mid 1990s. The other two factors were the Group of 30 Report and the 1996 amendment to the Basel Accord.

During the late 1980's, JP Morgan developed its own firm-wide value-at-risk system. This modeled several hundred key factors. A covariance matrix was updated quarterly from historical data. Each day, trading units would report by e-mail their positions' deltas with respect to each of the key factors. These were aggregated to express the combined portfolio's value as a linear polynomial of the key factors. From this, the standard deviation of portfolio value was calculated. Various VaR metrics were employed. One of these was one-day 95% USD VaR, which was calculated using an assumption that the portfolio's value was normally distributed.

With this VaR measure, JP Morgan replaced a cumbersome system of notional market risk limits with a simple system of VaR limits. Starting in 1990, VaR numbers were combined with P&L's in a report for each day's 4:15 PM Treasury meeting in New York. Those reports, with comments from the Treasury group, were forwarded to JP Morgan's Chairman Weatherstone.

One of the architects of the new VaR measure was Till Guldimann. His career with JP Morgan had positioned him to help develop and then promote the VaR measure within the firm. During the mid 1980's, he was responsible for the firm's asset-liability analysis. Working with other professionals, he developed concepts that would be used in the VaR measure. Later as chairman of the firm's market risk committee, he promoted the VaR measure internally. As fate would have it, Guldimann's next position placed him in a role to promote the VaR measure outside the firm.

In 1990 Guldimann took responsibility for JP Morgan's Global Research department, overseeing research activities to support marketing to institutional clients. In that capacity he managed an annual research conference for clients. In 1993, risk management was the conference theme. Guldimann gave the keynote address and arranged for a demonstration of JP Morgan's VaR system. The demonstration generated considerable interest. Clients asked if they might purchase or lease the system. Since JP Morgan was not a software vendor, they were disinclined to comply. Guldimann proposed an alternative. The firm would provide clients with the means to implement their own systems. JP Morgan would publish a methodology, distribute the necessary covariance matrix and encourage software vendors to develop compatible software.

Guldimann formed a small team to develop something for the next year's research conference. The service they developed was called RiskMetrics. It comprised a detailed technical document as well as a covariance matrix for several hundred key factors, which was updated daily. Both were distributed without charge over the Internet. The service was rolled out with considerable fanfare in October 1994. A public relations firm placed ads and articles in the financial press. Representatives of JP Morgan went on a multi-city tour to promote the service. Software vendors, who had received advance notice, started promoting compatible software. Launched at a time of global concerns about derivatives and leverage, the timing for RiskMetrics was perfect.

RiskMetrics was not a technical breakthrough. While the RiskMetrics Technical Document contained original ideas, for the most part, it described practices that were already widely used. The important contribution of RiskMetrics was that it publicized value-at-risk to a wide audience. Ultimately, JP Morgan spun RiskMetrics off as an independent consulting and software firm.

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