When the financial crisis exposed the flaws in investment banking's risk management in 2007 and 2008, regulators reached a number of important conclusions. The first was the role of credit default swaps (CDS) in magnifying the effects of subprime mortgage defaults. These instruments had been used to create credit exposures, especially through synthetic collateralised debt obligations (CDOs), that far outstripped the cash bond market itself.
The second was the incorrect use of existing tools for measuring market risk, especially in complex products such as CDOs, where pricing was affected by credit correlations. In particular, the Value at Risk (VaR) concept, which calculated the maximum daily loss likely to occur over a set period (usually 10 days) to within a certain probability (usually 95% to 99%), appeared to leave a number of vital blind spots.
