*A Multiple of the VaR*
By multiplying the VaR output, the aim is to provide a cushion against potential weaknesses in the model itself as well as some cover over and above the confidence level (e.g. 99%) used. Furthermore, the VaR output is the estimated maximum loss at a certain confidence level and in a given holding period. In reality, this level of loss might occur more than once in a short period of time.

*Pros*

- The multiplier covers potential weaknesses of the modelling approach such as fat tail issues.

- Multipliers are used by some firms to manage their market risk internally.

- Simple.

- Emphasises the relative riskiness of products (i.e. it loads significantly more capital onto riskier products).

*Cons*

- A multiplier might encourage firms that would otherwise take a conservative approach to calculating VaR to be less conservative in order to reduce the impact of the multiplier. The multiplier might therefore be a perverse incentive to design a model to minimise regulatory effects rather than optimise its use as a risk management tool.

- A low initial number from a flawed model will not be corrected by a multiplier.

- The particular multiplier chosen is open to the charge that it is arbitrary.

*(ii) Add-on Based on Stress testing*

Another approach would be to use VaR plus an add-on that reflects, in some fashion, the simulation of extreme market movements, including the breakdown of correlations and other assumptions.

*Pros*

- Risk based.

- Can capture liquidity and fat tail risks.

- Can provide a flexible tool to re-inforce supervisors' qualitative approach.

*Cons*

- It gives firms an incentive to tailor their stress testing to meet supervisory requirements.

- It is difficult to establish a consistent approach to the calculation of the add-on.