Value at Risk
What is Value at Risk?
Value at Risk (VaR) is the estimate of how much a set of investments or a single company might lose under normal market conditions, over a given period, usually a day. It is used by investment managers and regulators to estimate what sort of funds would be required to cover possible losses. It is a critical measure of financial risk.
Where have you heard about Value at Risk?
If you have ever read a risk assessment of a portfolio of investments, you may have come across the term Value at Risk.
What you need to know about Value at Risk...
Investment and commercial banks use the Value at Risk calculation to estimate the potential losses of their investment portfolios. But given the dynamics of modern investment markets, the VaR calculation dates very quickly and becomes progressively less useful the longer the time period to which it is applied.
Separately, VaR calculations are of little use in working out potential losses arising from so-called "black swan" events, extreme and unpredictable happenings. During the 2008 financial crisis, for example, VaR assessments were criticised for severely underestimating the risk of toxic mortgage products to banks, but the credit crunch was just such a black swan event.