VALUE AT RISK: AN OVERVIEW
Although an in-depth discussion of the various methods of calculating VaR is beyond the scope of this book, I will provide a general overview of the topic and why it is an important complement to traditional methods of price risk management (e.g., stop-loss and volumetric price risk management).5
Value-at-risk methodologies attempt to quantify the standard deviation (or historical volatility) of a trading asset or portfolio of assets and the historical correlations between these assets in order to answer the question: What is the likelihood of our losing X dollars or more over a specified time horizon under normal market conditions?” For example, a particular hedge fund might have a daily VaR of $30 million at the 95 percent confidence level. This would translate into there being a 95 percent probability of the portfolio not experiencing a loss in excess of $30 million over the next 24 hours.
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