What is VaR used for?
Not a food additive, yet. Originally VaR was used as an information tool. I.e., it was used to communicate to management a feeling for the exposure to changes in market prices. Then market risk was incorporated into the actual risk control structure. I.e., trading limits were based on VaR calculations. Now it is commonly used in the incentive structure as well. I.e., VaR is a component determining risk-adjusted performance and compensation. Interestingly, the theory of VaR has not kept pace. While we understand it’s usefulness as an information tool, it’s not clear how it fits into the shareholder wealth maximization paradigm of modern financial theory.
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