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VaR (Shortcomings (Coherency (Subadditivity; FAILS, Monotonicity, Positive…
VaR
Shortcomings
Coherency
Subadditivity;
FAILS
Monotonicity
Positive Homogeneity
Translation Invariance
Tail risk
Assumes normal distribution
Different Methodology for VaR calc among diff companies
Parametrical Method - Variance-covariance matrix
Historical Simulation - Simulate using historical data
Monte Carlo simulation
Historical Data & Observation Period
Hist. data can't predict future
Needs a broader observation period to capture extremes
Agency Problems
VaR-focused risk managers will panic as market volatility goes
Regulatory Disclosure
BCBS requirement on VaR model
Calculation Inputs
Normally distributed return
Std. dev
Confidence interval
Complementary tools
Stress testing
Stressed VaR
Stressed parameter from tail events
RM
Uses & Misuses
Corporate RM
Value-based => VaR
CF-based => reduce volatility
Conclusion
Only for TOTAL value RM
Apply very carefully to selective risk management
Can't replace a good RM