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Trading Strategies

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Introduction to Value at Risk (VaR)

Value at Risk fundamentals and concepts

Risk ModelingAll Asset Classes

Key Insights

VaR quantifies maximum expected loss at a specified confidence level over a defined time horizon
Parametric VaR uses the formula: VaR = z-score × portfolio standard deviation × portfolio value
95% confidence VaR means only 5% probability of exceeding the loss threshold
VaR is widely accepted by regulators and used for capital adequacy requirements
Must be complemented with Expected Shortfall and stress testing for comprehensive risk management
Assumes normal distribution of returns which may underestimate tail risks
Regular back-testing and model validation are essential for maintaining accuracy
Different calculation methods (parametric, historical, Monte Carlo) may yield different results

Understanding Value at Risk Fundamentals

Value at Risk (VaR) is a statistical measure that quantifies the potential loss in the value of a portfolio over a defined period for a given confidence interval. It answers the critical question: 'What is the largest possible loss my portfolio may incur with a specific probability?'

VaR has become the industry standard for risk measurement, providing a single number that represents the worst expected loss under normal market conditions. This makes it invaluable for risk management, regulatory compliance, and portfolio monitoring.

Understanding VaR concepts is fundamental for modern portfolio management, enabling quantitative risk assessment, capital allocation decisions, and systematic risk control across financial institutions.