Stock Markets Exposed

What is Value at Risk? Is it useful to analyze our periodic loss after invested in any stock?

Public Comments

1. Value-at-Risk is a marketing tool that makes people think they understand risk -- but has very little value (if any). To find VaR, look at the historical (or expected) distribution of returns. The VaR is the 5th percentile. For example, if you are looking at daily returns, the VaR will be the dollar loss at the 5th percentile. That is, on 95% of days, you will do better than that number and 5% of the time you will do worse. It doesn't measure how much worse you will do 5% of the time, nor does it say anything about the reward you get for taking on risk. If returns are normal or lognormal, then VaR doesn'[t tell you anything more than you would know by knowing volatility. It is a success, because it allows you to boil all your risk down to one simple number. It is a failure, because it boils all your risks down to one simple number. In my opinion, it is worthless. However, Basil II accords require certain financial institution to report it. Not everyone agrees with me. See the link below for other opinions.
2. Value-at-Risk (VaR) is a Risk Metric that states the maximum loss (in dollar or percentage terms) possible in a given time frame with a certain confidence level. There are three ways VaR is calculated: Historical Approach, Variance-Covariance method and Monte Carlo Simulations. The Historical Approach plots the returns on a histogram, with the assumption that history will repeat itself. The Variance-Covariance method is not very different other than the fact that here, the returns are plotted as 'normally distributed'. The Monte Carlo method is essentially a set of random trials to calculate VaR.