Question

How did AIG’s senior executive statement that writing credit derivatives was “free money” prove wrong and how could VaR helped them? (10 points)

Answer 1

AIG senior executive's statement that writing off credit derivatives was free money was completely in stark contrast with the reality as when the bubble popped up, the credit default swaps were enforcible and it could not be paid off because the housing sector lost it's complete value.

senior executive has perhaps estimated that housing properties are completely hedged against any kind of adverse economic movement and the value was completely realizable but that was in stark contrast with the reality because housing sector lost tremendous amount of value and it even led to AIG on the brink of bankruptcy.

Value at risk would have helped them because it had provided them with the probabilities of default and the probabilities of values going up and down along with the probability of the rate of depreciation in the value of the housing sector.