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  • Calculating Value at Risk (VaR) TOC

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    Jawwad Farid
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    One of the most pertinent questions in risk management has been: “How much do you stand to lose, over a certain period and with a certain probability? What is that number and what does it stand for?” The number being referred to here is Value at Risk (VaR): A worst case loss with limits on time period and probability. VaR uses historical market trends and volatilities to estimate the likelihood that a given portfolio’s losses will exceed a certain amount. The course aims to first provide a basic introduction to this common and widely used risk measurement tool and then present a non-traditional, market risk oriented application to show how it could be extended to address other interesting questions. Topics covered: A review of Value at Risk (VaR) calculation methods including; Variance-covariance (VCV) approach Historical simulation approach Monte Carlo simulation approach Creation of a simple portfolio and step-by-step calculation of its VaR under the first two approaches mentioned above. VaR issues and related caveats and qualifications pertaining to the use of this measure. VaR case-study demonstrating the application of VaR in a non-traditional, market risk oriented application, in particular the use of the value at risk (VaR) measure as a tool to forecast and predict the margin shortfall problem within the oil, gas and petrochemical industry. http://fourquants.com/elearning/store-2/#ecwid:mode=product&product=8408865

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    One of the most pertinent questions in risk management has been: “How much do you stand to lose, over a certain period and with a certain probability? What is that number and what does it stand for?” The number being referred to here is Value at Risk (VaR): A worst case loss with limits on time period and probability. VaR uses historical market trends and volatilities to estimate the likelihood that a given portfolio’s losses will exceed a certain amount. The course aims to first provide a basic introduction to this common and widely used risk measurement tool and then present a non-traditional, market risk oriented application to show how it could be extended to address other interesting questions. Topics covered: A review of Value at Risk (VaR) calculation methods including; Variance-covariance (VCV) approach Historical simulation approach Monte Carlo simulation approach Creation of a simple portfolio and step-by-step calculation of its VaR under the first two approaches mentioned above. VaR issues and related caveats and qualifications pertaining to the use of this measure. VaR case-study demonstrating the application of VaR in a non-traditional, market risk oriented application, in particular the use of the value at risk (VaR) measure as a tool to forecast and predict the margin shortfall problem within the oil, gas and petrochemical industry. http://fourquants.com/elearning/store-2/#ecwid:mode=product&product=8408865

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    695 views3 pages

    Calculating Value at Risk (VaR) TOC

    Uploaded by

    Jawwad Farid
    One of the most pertinent questions in risk management has been: “How much do you stand to lose, over a certain period and with a certain probability? What is that number and what does it stand for?” The number being referred to here is Value at Risk (VaR): A worst case loss with limits on time period and probability. VaR uses historical market trends and volatilities to estimate the likelihood that a given portfolio’s losses will exceed a certain amount. The course aims to first provide a basic introduction to this common and widely used risk measurement tool and then present a non-traditional, market risk oriented application to show how it could be extended to address other interesting questions. Topics covered: A review of Value at Risk (VaR) calculation methods including; Variance-covariance (VCV) approach Historical simulation approach Monte Carlo simulation approach Creation of a simple portfolio and step-by-step calculation of its VaR under the first two approaches mentioned above. VaR issues and related caveats and qualifications pertaining to the use of this measure. VaR case-study demonstrating the application of VaR in a non-traditional, market risk oriented application, in particular the use of the value at risk (VaR) measure as a tool to forecast and predict the margin shortfall problem within the oil, gas and petrochemical industry. http://fourquants.com/elearning/store-2/#ecwid:mode=product&product=8408865

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    of 3

    CALCULATING

    VALUE AT RISK

    By Jawwad Ahmed Farid


    C A L C U L A T I N G V A L U E A T R I S K

    CONTENTS
    CALCULATING VALUE AT RISK ....................................................................................................................... 4
    1. INTRODUCTION .................................................................................................................................. 4
    2. VAR METHODS .................................................................................................................................. 5
    a.
    b.
    c.
    d.
    e.
    3.

    Variance Covariance Approach ......................................................................................................... 6


    Historical Simulation Method ............................................................................................................ 7
    Monte Carlo Simulation ..................................................................................................................... 7
    Quick Review ...................................................................................................................................... 8
    Implementing VaR .............................................................................................................................. 8
    METHODOLOGY ................................................................................................................................. 8

    a. Setting the Scene ................................................................................................................................ 8


    Sample Portfolio ............................................................................................................................ 8
    b. Preliminary steps ............................................................................................................................... 9
    c. VaR Approach Specific Steps .............................................................................................................. 12
    Variance-Covariance (VCV) VaR .................................................................................................... 12
    Determining Historical Simulation daily VaR ................................................................................ 14
    d. Scaling of the daily VaR ...................................................................................................................... 15
    4. CAVEATS, QUALIFICATIONS, LIMITATIONS AND ISSUES ................................................................................ 15
    5. CASE STUDY RISK FOR THE OIL AND PETROCHEMICAL INDUSTRY ................................................................. 17
    a.
    b.
    c.
    d.
    e.
    f.

    A Framework for Risk Management ................................................................................................... 17


    Risk Policy ........................................................................................................................................... 18
    Good Data and a First Look at Models ............................................................................................... 19
    Models and Tools ............................................................................................................................... 20
    Metrics and Sensitivities .................................................................................................................... 24
    Limits and Control Process .................................................................................................................. 27
    Operational (Exception or Management Action) Limits ................................................................ 28
    Capital Loss & Stop Loss Limits ..................................................................................................... 28
    Inventory Age Limits ..................................................................................................................... 28
    Concentration Limits ..................................................................................................................... 28
    Transaction Limits ......................................................................................................................... 28
    Exposure and Sensitivity Limits ..................................................................................................... 28
    Pre-Settlement Risk (PSR) and Potential Future Exposure (PFE) Limits ........................................ 28
    Hierarchy of Limits ........................................................................................................................ 29
    g. Conclusion .......................................................................................................................................... 30
    BIBLIOGRAPHY .......................................................................................................................................... 31
    DISCLAIMER .............................................................................................................................................. 32

    Please do not photocopy or distribute without permission. All rights reserved Alchemy Software Pvt Limited.
    http://FourQuants.com
    Page 3 of 32

    C A L C U L A T I N G V A L U E A T R I S K

    B IBLIOGRAPHY
    1. Understanding Market, Credit and Operational Risk- The Value at Risk Approach, Linda Allen,
    Jacob Boudoukh and Anthony Saunders,Blackwell Publishing, 2004
    2. Beyond Value at Risk, The New Science of Risk Management, Kevin Dowd, John Wiley &
    Sons, 1998
    3. Higher-Order Simulations: Strategic Investment Under Model-Induced Price Patterns, Gilbert
    Peffer and Brbara Llacay, Journal of Artificial Societies and Social Simulation vol. 10, no. 2, 6
    <http://jasss.soc.surrey.ac.uk/10/2/6.html>, 2007
    4. The Black Swan, the impact of the highly improbable, Nassim Nicholas Taleb, Random
    House, 2007
    5. Risk Frameworks and Applications- 2nd Edition, Jawwad A. Farid, 2011

    Please do not photocopy or distribute without permission. All rights reserved Alchemy Software Pvt Limited.
    http://FourQuants.com
    Page 31 of 32

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