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Value at Risk

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nikki padilla

on 28 October 2013

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Transcript of Value at Risk

Value at Risk
expected loss
of a portfolio over a specified time period for a set level of probability”
VaR may produce errors
VaR is one of the widely used methods in determining the expected loss.
Even if it is deemed to be one of the
, it also has its
when used improperly
We could not say that VAR is exactly good or bad (there are some advantages and disadvantages with it)
History & Facts
“What is the most I can lose on this investment?”
3 Methods
Historical Simulation
reorganizes actual historical returns from

Monte Carlo Simulation
develops a model for the future stock prices and runs multiple hypothetical trials
assumes that stock returns are normally distributed
The Variance-Covariance Approach
derives historical risk measures
applies these risk measures to the current portfolio
derive the value at risk
like standard deviation & correlation
(after breaking down the portfolio into standard instruments)
Advantages and Disadvantages
of VaR
easy and simple to compute.
measures potential losses in simple terms
question asked is as simple as “How bad can things get?
more difficult to calculate with larger portfolios
different methods of VaR may produce varying results
service developed by
Till Guldimann and his team
able to make variances in and covariances across asset classes
freely available to anyone
who wanted to access them
Normal Distribution
The chosen distribution might not adequately approximate the actual distribution of the market factors.
History may not be a good predictor
Relying on histories may result to either overestimated or underestimated VaR.
Type of Risk
Value at Risk can be much greater than the computed Value at Risk if one considers political risk, liquidity risk and regulatory risks that are not built into the VaR.
The quality of the VaR estimates quickly deteriorate as you go from daily to weekly to monthly to annual measures.
Over exposure to Risk
By not bringing in the magnitude of the losses once you exceed the VaR cut-off probability they are opening themselves to the possibility of very large losses in the worst case scenarios.
Agency Problems
Value at Risk can be gamed by managers who have decided to make an investment and want to meet the VaR risk constraint.
VAR: not a panacea
"despite its many benefits to certain firms, VAR is not a panacea"
will not do to help a firm
(well-developed policies and management )
"VAR may
not always
help a firm accomplish its risk management objectives"
For ex:
(lack of internal management and control over the treasurer) and
(top officers lost control over trading operation)(1993-1995)
Submitted By
Carino, Michelle C
Chua, Michael
Ho, Hanna Christelle C.
Lee, Seung Joo
Padilla, Nikki T.
Full transcript