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PORTFOLIO

VAR
ESTIMATION
Husam Sawalha
Leen Bargouth

Muna Ghosheh
Flora Mansour

INTRODUCTION

A portfolio was built by choosing the following stocks


from Amman stock exchange :

Jordan Ahli Bank.


The Jordan Cement Factories.
Jordan Poultry Processing & Marketing.
Jordan Diary.

The historical data of those stocks was collected for the


most recent 501 days

INTRODUCTION

J.D 10,000 was invested in this portfolio allocated


as follow :
Our Companies

Value of investment

AHLI

4000

JO CEMENT

3000

JO POULTARY

2000

JO DAIRY

1000

Total

10,000

INTRODUCTION

Portfolio VaR was estimated according to the


following approaches:
Standard

Approach.
Historical Simulation Approach :

Basic historical simulation approach.

Adjusted weighting historical simulation approach.

Volatility Adjusted approach ( EWMA & GARCH Models).

Model-Building

Equal-Weights

EWMA

Approach :

METHODOLOGY OF WORK

First of all, the normality of stocks returns was tested,


to ensure returns are normally distributed, so that no
out layer number that may effect our estimation of VaR
.
Secondly, VaR was estimated based on standard
approach.
Thirdly, under the Historical Simulation Approach, 500
alternative scenarios was built based on 501 returns of
stocks, to estimate the probability distribution of the
change in the value of the current portfolio
Finally, under the Model-Building Approach, the
covariance matrix between stocks returns was built
and used in estimation.

NORMALITY TEST
All portfolio stocks returns are normally
distributed or semi normally.
The descriptive analysis of returns was made,
and the values of Kurtosis and Skewness was
checked as follow:

Skewness

Kurtosis

Stock

0.304856

8.884672

AHLI

-0.331869

0.617962

JOCM

0.591727

1.772698

JPPC

-0.189063

3.460736

JODA

STANDARD APPROACH
Based

on returns of portfolio, the


mean and standard deviation was
calculated.
The following formula was used to
estimate VaR :
VaR N 1 ( X )

HISTORICAL SIMULATION
APPROACH

Basic

Historical Simulation:

According to Basic historical simulation approach:


VaR is based on historical scenarios of losses .we collect the historical data on their
returns over a set observation period Each scenario -or day outcome- is given equal
weight, which is 1/number of scenarios .

for each asset and each t in the observation period, we generate scenarios by
calculating the return (% change) on each of the assets. Here is the formula to
calculate the percentage price changes: (price t - price t-1) / price t-1 or (ln t) .

For 500 scenarios , the one-day 99% VaR can be estimated as the fifth-worst loss.
no of observations=500, 1-.99=10% ,10%*500=5
Then we find mean and standard deviation and according to the equation:
Mean-Z(n)*standard deviation
Wefind the historical var

HISTORICAL SIMULATION
APPROACH

We suggest that more recent observations should be given more weights because they
are more reflective of current volatilities and current macroeconomic conditions .
We calculate the weights by choosing lambda = 0.94

and our formula .


n-i (1- )
1- n
Where
n: number of observation .
i : scenario number,
i=1 is the scenario that calculated from the most distant data.
: can be chosen by experimenting to see which value back-test best .
As approaches 1, the relative weights are approach the equal weight.
Then we do a cumulative weight column for our weights
Starting at the most worst observation sum weight until the required quintile of
distribution is reached( we are calculating VaR with 99% confidence level) , so we
continue summing weight until the cumulative weight is just greater that 0.01 .

CALCULATING VAR USING THE HISTORICAL


SIMULATION VOLATILITY-ADJUSTED
APPROACH (EWMA)
In

this part volatility of each scenario


was taken into consideration .

This

approach will produce VAR


estimation that incorporate the
volatility of current information

PROCEDURE OF VOLATILITY
ESTIMATION USING EWMA
Calculate

daily variance
The following equation used to produce new variance

2n 2n 1 (1 )u n21
Then we find standard deviation which is the
Square root of variance
Then we make volatility multiplier:
Last sd/1st sd, last sd/2nd sd
Then we multiply volatility*losses
Var=1-95%=5% we will find the 5th loss from the
bottom
assumed to be .94

Adjusted prices are then calculated using the following


formula :
vn

vi 1 (vi vi 1 ) n 1 / i
vi 1

MODEL-BUILDING APPROACH
The

main alternative to historical


simulation is to make assumptions
about the probability distributions of
the returns on the market variables
is known as the model
building approach (or sometimes
the variance-covariance approach).

This

MODEL-BUILDING APPROACH
Daily changes in the value of a portfolio equal the
total daily changes in the values of individual
stocks.
This approach based on the assumption that daily
changes of the values of individual stocks are
normally distributed and so daily changes in the
value of the portfolio are normally distributed.
The variance of the daily changes of portfolio value
is given by:

cov ij i j
2
P

i 1 j 1

PROCEDURE OF ESTIMATING VAR


IN MODEL-BUILDING APPROACH
Calculate

daily returns for each stock.


Based on the following equation, the
variance of portfolio is calculated

Then

2
P

cov
i 1

j 1

ij

i j

VaR of the portfolio is estimated.

USING EWMA IN MODELBUILDING APPROACH


Instead

of using equal weights, Exponentially


weighted average method with certain value could
be used.

Firstly,

calculate variance of each stocks returns


using

Secondly,

using

calculate covariance for each pair of stocks

Finally,

build the variance-covariance matrix to


calculate portfolio variance

Then

VaR of the portfolio can be estimated.