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   Value At Risk (VAR)
   















 

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Value At Risk (VAR)

A Value At Risk (Daily Earnings at Risk) Diagram
(1) A currency-denominated measurement of the loss a dealer or an end-user of financial instruments would experience in the event of, say, a two standard deviation adverse move in reference prices or rates in the course of a day or other standardized period. Non-dealers, especially those who mark their portfolios to the market less frequently than daily, may use longer periods. While value at risk is increasingly the dominant risk measurement technique, users must be alert to the implicit assumptions that historic price or rate volatility is an appropriate 'gauge' of likely future volatility, and that the distribution is approximately normal. VAR should always be supplemented by a stress test or other technique designed to test the sensitivity of the results to the underlying assumptions. A one day VAR calculation is often called Daily Earnings at Risk (DEaR). (2) Value at risk is sometimes defined as the daily calculation for value at risk multiplied by the square root of the time required to close out a position. A careful study of the way in which some value at risk calculations change with time will suggest that this square root of time calculation probably understates the risk, particularly of some illiquid positions. Careful attention to the assumptions and algorithms in any VAR calculation is essential. See also Add-On, Capital at Risk, Daily Earnings at Risk (DEaR), Cash Flow Sensitivity Analysis.

Find out about the role of DeaR and VAR in market risk capital by clicking on "Key Risk Concepts: Market Risk"

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