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VALUE AT RISK
MODELLING
VALUE AT RISK
MARKET RISK MODELLING
MAXIMUM AMOUNT that can be lost in a given period of time with a given level of
confidence
We are X percent certain, that we will not lose more than V in time T
It measures ONLY the downside
It can measure the Market Risk for all kinds of asset, with some modifications required
for Fixed Income Securities
The limitation of VaR is that we are not sure what happens 1% of time in a 99%
confidence level
APPROACHES TO CALCULATE VALUE AT RISK
Parametric Approach
Historical Simulation
Exponentially Weighted Historical Simulation
Monte Carlo Simulation (Normal)
Monte Carlo Simulation (Log Normal)
Monte Carlo Simulation (Brownian Movement)
PARAMETRIC APPROACH
The Historical Simulation relies on data from the PAST to derive the VaR which is one of
the possible disadvantage of the method
One alternative to using past events to model what might happen in the future is to use
Excel to predict conditions that might occur in the future, and then model what would
happen to the assets within a portfolio under those future conditions. This concept is the
basis of the Monte Carlo Simulation method of calculating VaR
Using Excel, a Monte Carlo Simulation randomly generates possible future scenarios (or
market conditions). The value of the portfolio being assessed is then calculated for each
set of market conditions generated.
ASSIGNMENT