What is Value At Risk?
Used as a measurement of market risk by several different types of financial institutions, a value of risk involves the maximum amount of loss that is anticipated to occur with a given investment opportunity. The value at risk is calculated using three basic components or parameters, all of which are considered to be solid economic indicators. Determining a value at risk is a common practice and is often used as part of the process of predicting the worst case scenario that is expected to occur with a given security within a specified period of time. Three factors of parameters form the foundation for calculating the value at risk, or VAR. The first factor has to do with the time period that the financial institution is required to hold on to the security. Sometimes referred to as the time horizon, this factor helps to establish the time frame for the projection on performance. A time horizon may range from a single twenty-four hour period, a successive period of ten days, or up to one
B. Venkatesh THE Securities and Exchange Board of India (SEBI) wants to introduce a margin system based on value-at-risk (VaR) model. What is VaR ? VaR is the maximum loss you are likely to incur on your portfolio during a certain period. Suppose your model throws up a one-day VaR of Rs 10,000 on your portfolio of Rs 5 lakh at a 95 per cent confidence level. This means your one-day loss will be not more than Rs 10,000 in 95 out of 100 trading days. VaR is only an estimate. This means there is a likelihood or probability of you losing not more than the VaR on most days. In the above example, we are 95 per cent likely to lose not more than Rs 10,000. This also means we are 5 per cent likely to lose more than Rs 10,000 on certain days. VaR, thus, depends on the confidence level. If you want to be more conservative in knowing your likely losses, you have to increase the confidence level to, say, 99 per cent. Suppose, the daily VaR at a 99 per cent confidence level is Rs 20,000 on the above
