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Calculating Value at Risk (VaR) TOC

One of the most pertinent questions in risk management has been: “How much do you stand to lose, over a certain period and with a certain probability? What is that number and what does it stand for?” The number being referred to here is Value at Risk (VaR): A worst case loss with limits on time period and probability. VaR uses historical market trends and volatilities to estimate the likelihood that a given portfolio’s losses will exceed a certain amount. The course aims to first provide a basic introduction to this common and widely used risk measurement tool and then present a non-traditional, market risk oriented application to show how it could be extended to address other interesting questions. Topics covered: A review of Value at Risk (VaR) calculation methods including; Variance-covariance (VCV) approach Historical simulation approach Monte Carlo simulation approach Creation of a simple portfolio and step-by-step calculation of its VaR under the first two approaches mentioned above. VaR issues and related caveats and qualifications pertaining to the use of this measure. VaR case-study demonstrating the application of VaR in a non-traditional, market risk oriented application, in particular the use of the value at risk (VaR) measure as a tool to forecast and predict the margin shortfall problem within the oil, gas and petrochemical industry. http://fourquants.com/elearning/store-2/#ecwid:mode=product&product=8408865

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Jawwad Farid
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886 views3 pages

Calculating Value at Risk (VaR) TOC

One of the most pertinent questions in risk management has been: “How much do you stand to lose, over a certain period and with a certain probability? What is that number and what does it stand for?” The number being referred to here is Value at Risk (VaR): A worst case loss with limits on time period and probability. VaR uses historical market trends and volatilities to estimate the likelihood that a given portfolio’s losses will exceed a certain amount. The course aims to first provide a basic introduction to this common and widely used risk measurement tool and then present a non-traditional, market risk oriented application to show how it could be extended to address other interesting questions. Topics covered: A review of Value at Risk (VaR) calculation methods including; Variance-covariance (VCV) approach Historical simulation approach Monte Carlo simulation approach Creation of a simple portfolio and step-by-step calculation of its VaR under the first two approaches mentioned above. VaR issues and related caveats and qualifications pertaining to the use of this measure. VaR case-study demonstrating the application of VaR in a non-traditional, market risk oriented application, in particular the use of the value at risk (VaR) measure as a tool to forecast and predict the margin shortfall problem within the oil, gas and petrochemical industry. http://fourquants.com/elearning/store-2/#ecwid:mode=product&product=8408865

Uploaded by

Jawwad Farid
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© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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You are on page 1/ 3

CALCULATING

VALUE AT RISK

By Jawwad Ahmed Farid


C A L C U L A T I N G V A L U E A T R I S K

CONTENTS
CALCULATING VALUE AT RISK ....................................................................................................................... 4
1. INTRODUCTION .................................................................................................................................. 4
2. VAR METHODS .................................................................................................................................. 5
a.
b.
c.
d.
e.
3.

Variance Covariance Approach ......................................................................................................... 6


Historical Simulation Method ............................................................................................................ 7
Monte Carlo Simulation ..................................................................................................................... 7
Quick Review ...................................................................................................................................... 8
Implementing VaR .............................................................................................................................. 8
METHODOLOGY ................................................................................................................................. 8

a. Setting the Scene ................................................................................................................................ 8


Sample Portfolio ............................................................................................................................ 8
b. Preliminary steps ............................................................................................................................... 9
c. VaR Approach Specific Steps .............................................................................................................. 12
Variance-Covariance (VCV) VaR .................................................................................................... 12
Determining Historical Simulation daily VaR ................................................................................ 14
d. Scaling of the daily VaR ...................................................................................................................... 15
4. CAVEATS, QUALIFICATIONS, LIMITATIONS AND ISSUES ................................................................................ 15
5. CASE STUDY RISK FOR THE OIL AND PETROCHEMICAL INDUSTRY ................................................................. 17
a.
b.
c.
d.
e.
f.

A Framework for Risk Management ................................................................................................... 17


Risk Policy ........................................................................................................................................... 18
Good Data and a First Look at Models ............................................................................................... 19
Models and Tools ............................................................................................................................... 20
Metrics and Sensitivities .................................................................................................................... 24
Limits and Control Process .................................................................................................................. 27
Operational (Exception or Management Action) Limits ................................................................ 28
Capital Loss & Stop Loss Limits ..................................................................................................... 28
Inventory Age Limits ..................................................................................................................... 28
Concentration Limits ..................................................................................................................... 28
Transaction Limits ......................................................................................................................... 28
Exposure and Sensitivity Limits ..................................................................................................... 28
Pre-Settlement Risk (PSR) and Potential Future Exposure (PFE) Limits ........................................ 28
Hierarchy of Limits ........................................................................................................................ 29
g. Conclusion .......................................................................................................................................... 30
BIBLIOGRAPHY .......................................................................................................................................... 31
DISCLAIMER .............................................................................................................................................. 32

Please do not photocopy or distribute without permission. All rights reserved Alchemy Software Pvt Limited.
http://FourQuants.com
Page 3 of 32

C A L C U L A T I N G V A L U E A T R I S K

B IBLIOGRAPHY
1. Understanding Market, Credit and Operational Risk- The Value at Risk Approach, Linda Allen,
Jacob Boudoukh and Anthony Saunders,Blackwell Publishing, 2004
2. Beyond Value at Risk, The New Science of Risk Management, Kevin Dowd, John Wiley &
Sons, 1998
3. Higher-Order Simulations: Strategic Investment Under Model-Induced Price Patterns, Gilbert
Peffer and Brbara Llacay, Journal of Artificial Societies and Social Simulation vol. 10, no. 2, 6
<http://jasss.soc.surrey.ac.uk/10/2/6.html>, 2007
4. The Black Swan, the impact of the highly improbable, Nassim Nicholas Taleb, Random
House, 2007
5. Risk Frameworks and Applications- 2nd Edition, Jawwad A. Farid, 2011

Please do not photocopy or distribute without permission. All rights reserved Alchemy Software Pvt Limited.
http://FourQuants.com
Page 31 of 32

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