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Value-at-risk

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Value-at-risk
Formally, the probabilistic bound of market losses over a given period of time (known as the holding period) expressed in terms of a specified degree of certainty (the confidence interval). Put more simply, the value-at-Risk (VAR) is the worst-case loss expected over the holding period within the probability set out by the confidence interval. Larger losses are possible, but with a Low probability. For instance, a Portfolio whose VAR is $20 million over a one-day holding period, with a 95% confidence interval, would have only a 5% chance of suffering an overnight loss greater than $20 million. Calculation of VAR entails modelling the possible market moves over the holding period, incorporating correlations among market factors, calculating the impact of such potential market moves on Portfolio positions, and combining the results to examine Risk at different levels of Aggregation. The three main approaches to this analysis are historical simulation, the analytical approach using a Correlation matrix or empirical (Monte Carlo) simulation. Major trading houses expend considerable energies on their VAR methodologies and have lobbied regulators to recognise their efforts, with some success.
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