# How to calculate the VaR ( Value at risk)?

Risk management: How to calculate the VaR ( Value at risk) and what is its use?

Risk management: How to calculate the VaR ( Value at risk) and what is its use?

- Anoop. The VaR is basically just the quantile of the profit-and-loss distribution of, e.g., a portfolio. A informal and incorrect, but often used, definition would be that the VaR tells you what you can loose at a given probability. However, this is incorrect. There are two correct informal definitions. Assume that we look at the 95% VaR over a fixed time interval.

1.

The 95% VAR tells you your maximum loss in the 95% best cases

2.

The 95%VAR tells you your minimum loss in the 5% worst cases.

From these definitions, you should notice that for risk management, VaR does not really make sense. Think of yourself as a risk manager. So if you look at the definition in 2., it says that you only look at the best case of your 5% worst cases. This does not make sense and, from a utility viewpoint, it means that you would be a risk loving risk manager. It would be better to use e.g. Expected Shortfall as a risk measure. This measure looks at the average of, say, the 5% worst cases. In utility terms, this would mean that you would be a risk-neutral risk manager, as you put equal weight to all 5% worst cases. Spectral measures go one step further and generalize this weighting scheme so as to be consistent with risk-averse risk managers... I hope these short reply helps.

Best,

markus - Thanks a lot sir.... I appreciate your reply. It has started my search process. Thanks again
- Check Paul Wimott's excel spreadsheet that calculates Var

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&ved=0CCEQFjAA&url=http%3A%2F%2Fsamba.fsv.cuni.cz%2F~blahaz%2FWilmott%2520ch%252020%2520Value%2520at%2520Risk.xls&ei=mNZSUIPaLJKk0AW-g4Ao&usg=AFQjCNFuqF4mN30_-7DlMa7_WLjCzbUGGg&sig2=gNT6iQJML1tuAns3rlq4AQ

also a talk.

http://www.youtube.com/watch?v=WK-_8dNoxcc - ...just a as a short remark: For risk management, one should really not rely too much on VaR. It does not say anything about how bad things can get when they are bad. But this is the question a risk manager has to pose. In other words, VaR is not a so-called coherent risk measure in general. Only when the underlying returns are normal distributed. But "normal distributed" is a misnomer (we should call it Gaussian distribution), as it suggests that normally returns are normal distributed. And even if returns are Gaussian distributed, if one has nonlinear payoffs in the portfolio (such as options), the portfolio is certainly no longer Gaussian and, hence, VaR is of limited use.
- I used this site to explain the concepts of VaR and volatility for some customers. It may be useful for your research.

http://www.riskglossary.com/

Already a member? Log in

## All Answers (5)