Value at Risk (VaR) models are being used extensively in the world of risk management. VaR provides an upper bound on the potential loss due to adverse market fluctuations. VaR can be used to estimate risk in the case of various financial instruments including bonds, equities and derivatives.
Since the past decade or so no other tool in financial risk management has been heard about as much as Value at Risk (VaR) modeling. VaR has rapidly become the industry standard for measuring and reporting market risk in trading portfolios of banks and other trading institutions.
VaR provides an upper bound on the potential loss due to adverse market fluctuations. Any VaR number has to specify which portfolio is being considered (e.g., Equity derivatives book), the confidence level (e.g., 97.5%) and the holding period (e.g., 10 days). VaR objectively tries to combine the sensitivity of the portfolio to market changes and the probability of a given market change.
VaR has been adopted by the Basel Committee to set the standard for the minimum amount of capital to be held against the market risks. VaR can be used to estimate risk in the case of various financial instruments including bonds, equities and derivatives. VaR can be used to communicate risk and to control risk by setting limits for frontline traders and operating managers. |
