COMPREHENSIVE

VALUE AT RISK
MODELLING
VALUE AT RISK
MARKET RISK MODELLING
MAXIMUM AMOUNT that can be lost in a given period of time with a given level of
confidence
We are X percent certain, that we will not lose more than V in time T
It measures ONLY the downside
It can measure the Market Risk for all kinds of asset, with some modifications required
for Fixed Income Securities
The limitation of VaR is that we are not sure what happens 1% of time in a 99%
confidence level
APPROACHES TO CALCULATE VALUE AT RISK

Parametric Approach
Historical Simulation
Exponentially Weighted Historical Simulation
Monte Carlo Simulation (Normal)
Monte Carlo Simulation (Log Normal)
Monte Carlo Simulation (Brownian Movement)
PARAMETRIC APPROACH

Daily Returns are calculated for a Portfolio

Using the Daily Returns for a period of time, we calculate the Standard Deviation (Sigma)
For a 99% confidence level, we use Norm Inverse of 0.99 to get a value of 2.33
Multiplying the Sigma with Norm Inverse of 0.99 we get the ONE DAY VaR @ 99%
confidence level
Multiplying a ONE DAY VaR with SQRT of Number of Days will give us VaR for the
period.
HISTORICAL SIMULATION

We have n days of Historical Data, today being the nth day

Let Vi be the value of the variable at Day I
There are (n-1) simulation trials
The ith trial assumes that the value of the variable tomorrow (i.e. on Day n+1, would be (Vn *Vi/Vi-1)
We calculate the S (Simulated Value) for each day of the historical data available.
We calculate the difference between the Simulated Value arrived to the Price on Day n.
We then RANK the differences keeping the maximum loss at the TOP.
We select the loss corresponding to the confidence level desired to calculate the Value at Risk.
EXPONENTIALLY WEIGHTED HISTORICAL
SIMULATION
It is the same as Historical Simulation with the difference being that weights are assigned to the
historical data points basis how recent they are
This is derived from the logic that something which has happened recently has more chances of
reoccurring than something which has happened in the distant past.
For assigning weights to the Historical Data, we have Lambda() which is between 0 and 1
We use the formula i-1 *(1- ) / 1- n
Once the weights have been assigned, we again rank the differences with the maximum loss at the TOP.
We figure out the DATA POINT where the summation of weights for the all the points above it and
including it is 0.01 for a confidence level of 99%.
The DATA POINT is then used for VaR calculations
MONTE CARLO SIMULATION

The Historical Simulation relies on data from the PAST to derive the VaR which is one of
the possible disadvantage of the method
One alternative to using past events to model what might happen in the future is to use
Excel to predict conditions that might occur in the future, and then model what would
happen to the assets within a portfolio under those future conditions. This concept is the
basis of the Monte Carlo Simulation method of calculating VaR
Using Excel, a Monte Carlo Simulation randomly generates possible future scenarios (or
market conditions). The value of the portfolio being assessed is then calculated for each
set of market conditions generated.
ASSIGNMENT

Bajaj ITC RIL SBI TCS Portfolio

WEIGHTS 10% 20% 30% 20% 20% 100%

Comprehensive VaR Modelling

Bajaj ITC RIL SBI TCS Portfolio
VaR (Parametric) 3.12% 5.61% 3.45% 4.58% 3.21% 2.05%
VaR (Historical Simulation) 3.06% 3.56% 3.58% 5.32% 4.05% 2.05%
VaR (Exponential Simulation) 2.76% 3.56% 2.69% 5.58% 3.58% 1.85%
VaR (Monte Carlo Normal) 3.13% 5.46% 3.25% 4.46% 3.19% 2.02%
VaR (Monte Carlo Log Normal) 3.13% 5.54% 3.56% 4.83% 3.29% 2.14%