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Value At Risk (VaR) BullGlobe

Value At Risk (VaR)

Value at Risk (VaR)

Value at Risk (or VaR) is a measure that is used to statistically quantify the level of risk of a certain investment over a specific period of time. It essentially estimates the potential losses you may encounter in a given timeframe (days, months, years, etc.) for a given probability. VaR can be a really powerful tool to manage your investment risk. For instance, an investment’s monthly VaR could tell you that there is a 95% chance that you will not lose more than 5% of your investment in a month.

This metric has three basic components that you need to understand:

  1. The confidence level is the statistical probability element. In the previous example, we used 95% as our confidence level. This is essentially saying that only in 5% of the cases analyzed (100% of cases – 95% confidence level), the estimated loss was more than 5% of your investment.
  2. Possible loss is the value that can be lost (hence Value at Risk) in a given period of time. In the previous example, we found 5% as the maximum possible loss with a 95% confidence level.
  3. The timeframe is the period of time in which we predict the losses can happen. In the previous example, the maximum possible losses to be incurred were in one month’s time. VaR can analyze daily, monthly, or yearly potential losses.

If we combine these three components we can form the following critical question:

“With a certain level of confidence (1), what is the most amount of money (2) that I can expect to lose in a given timeframe (3)?”

The above chart is an example of how we display a portfolio’s Value at Risk. We analyze the VaR at three levels of confidence (95%99%, and 99.9%) and compare a specific portfolio with the market benchmark and with its optimized version (which we create).

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