Value at Risk

We talked about value at risk last week. Dr. Grace also posted the formulas about how to calculate value at risk at an x% percentile. I did a little bit more research on value at risk and here is what I have found.

Value at risk is the maximum loss that doesn’t exceed with a given probability defined as a confidence level, over a period of time. VaR is a general tool and has a very broad range of application. However, VaR is most commonly used by security firms such as investment banks. VaR is used to measure the risk of the company’s portfolio assets over a given time period.


VaR is measured using the normal distribution. The actual value is converted by using the Z-value, which is also the standard normal distribution. VaR is very easy to understand and familiarize with. Anyway, there is an advantage of using this measurement. If the measured event is a rare event, it only occurs once a year. In order to use the VaR, a large amount of dates will be required before application. Other events that occur once a century, like a stock market crash, is impossible to value its risk accurately. Hedging probably can reduce the portfolio’s risk.

For many institutions, VaR is a very effective prospective measurement to apply. You can find more detailed calculation on the following websites.


http://en.wikipedia.org/wiki/Value_at_risk

http://www.riskglossary.com/link/value_at_risk.htm