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