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VALUE AT RISK (VAR), Assessment, Daniela Hernández Martínez Sebastián…

- - - - The Great Depression and the bank failures of the era
        
        Securities Exchange Commission (SEC) required banks to keep their borrowings below 2000% of their equity capital
        
        Banks could achieve this using devices to measure risk
      - The increased risk created from derivative markets and floating exchange
        rates in 1970s
        
        For this, Uniform Net Capital Rule (UNCR) categorize financial institutions in 12 classes
        
        This requeired Banks to report their capital
        statements quarterly to Financial and Operating Combined Uniform Single (FOCUS)
  - - - "Estimating onemonth 95% VaRs and hold enough capital to cover the potential losses"
  - - - Based on the covariance in yields on bonds of different maturities
      - In 1990s were developed variations and more rubust measurements of the VAR
        
        In 1995 JP Morgan created and published the "RiskMetrics"
- - - - Normal Risk /Market Risk
      - Abnormal Risk/Non Market Risk
  - - - Taking into account that VAR focus on measuring potential losses
        
        Example:
        
        Banks use it due to the fear of liquidity crises
        
        Use of 3 key elements
        
        Fixed time period
        
        Specific level of loss in value
        
        Confidence Interval
        
        Although there are common terms of the market risk that must be taken into account such as interest rate changes, equity market volatility and economic growth, it must be also taken into account the specific context in terms of competitive and firm specific risk for the asset or group of assets analyzed
- - - - Simple but limited
        
        Common probability measures
        
        Value unlikely to rise or drop by twice the standard deviation, regarding the mean
        
        If mean = 10 and StD = 2, value is unikely to rise above 12 or drop below 8
        
        Risk Mapping
        
        Used to simplify the calculus of many covariances in large portfolios
        
        Identify instruments that affect portfolio risk
        
        Estimate instrument variances, as well as covariances between them
        
        VaR calculus using weight of instruments, and their variances and covariances
    - - J.P. Morgan Service
        
        Easier computation of VaR for analysis
        
        Publicly available variances and covariances across asset classes.
      - General Assumptions for VaR computation
        
        Returns for individual risk factors follow conditional normal distributions
        
        Standarized returns
        
        Return divided by forecasted standard deviation
        
        Return size shall not be the focus
        
        Instead, its size relative to st. deviation
        
        They are analyzed considering current volatility
- - - - Computed VaR will understate the true measure
        
        True VaR will be much higher
      - Might have more outliers than expected
  - - - There is a slight error associated to the calculus with historical data
        
        Variance & covariance are estimates with error terms
  - - - Can alter or even breakdown computed VaR
- - - - Very difficult task
  - - - Heteroskedasticity
        
        Models such as ARCH and GARCH
  - - - Cannot incorporate options