VaR Risk Measurement
The VaR risk measure is a popular way to aggregate risk across an institution. Individual business units have risk measures such as duration for a fixed income portfolio or beta for an equity business. These cannot be combined in a meaningful way. It is also difficult to aggregate results available at different times, such as positions marked in different time zones, or a high frequency trading desk with a business holding relatively illiquid positions. But since every business contributes to profit and loss in an additive fashion, and many financial businesses mark-to-market daily, it is natural to define firm-wide risk using the distribution of possible losses at a fixed point in the future.
In risk measurement, VaR is usually reported alongside other risk metrics such as standard deviation, expected shortfall and “greeks” (partial derivatives of portfolio value with respect to market factors). VaR is a distribution-free metric, that is it does not depend on assumptions about the probability distribution of future gains and losses. The probability level is chosen deep enough in the left tail of the loss distribution to be relevant for risk decisions, but not so deep as to be difficult to estimate with accuracy.
Read more about this topic: Value At Risk
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