Calculating Value at Risk (VaR) – Topic Guide

 One of the most pertinent questions in risk management has been: “How much do you stand to lose, over a certain period and with a certain probability? What is that number and what does it stand for?“ The number being referred to here is Value at Risk or VaR for short: A worst case loss with limits on time period and probability. VaR uses historical market trends and volatilities to estimate the likelihood that a given portfolio’s losses will exceed a certain amount.

Topics covered

1. A review of Value at Risk (VaR) calculation methods including;
• Variance-covariance (VCV) approach
• Historical simulation approach
• Monte Carlo simulation approach
2. Creation of a simple portfolio and step-by-step calculation of its VaR under the first two approaches mentioned above.
3. VaR case-study demonstrating the application of VaR in a non-traditional, market risk oriented application, in particular the use of the value at risk (VaR) measure as a tool to forecast and predict the margin shortfall problem within the oil, gas and petrochemical industry.
4. VaR issues and related caveats and qualifications pertaining to the use of this measure.
5. Adjusting market risk VaR estimates for market liquidity risk

EXCEL files

The pre-packaged deal also includes the following 3 EXCEL files:

1. Calculating VaR – EXCEL Example. This is the supporting excel file to the PDF note with the same name, i.e. Calculating VaR.
2. Portfolio VaR – EXCEL Example. This is the detailed VaR worksheet for a portfolio comprising of commodities and currencies. This course complements our video course on Calculating VaR (not included in this package). It includes:
• Calculation of value at risk under the VCV and historical simulation approaches.
• Calculation of 10- day Trailing volatility
• Calculation of daily, holding period and annualized volatility
• Demonstration of how the in-built Histogram (Data Analysis) function of EXCEL id used to determine the worst case loss for the historical simulation approach.
• Comparison of results from various approaches
• Calculations of Portfolio VaR using the Variance Covariance Matrix multiplication approach as well as the weighted average portfolio return approach
• Differentiation between Price and Rate Value; Delta Neutral approximation and full valuation approach
3. VaR with liquidity premium – EXCEL Example. This is the supporting worksheet to the PDF “Adjusting market risk VaR estimates for market liquidity risk” included in the package. The file illustrates the calculation of the market risk measure for Rate VaR, Delta-normal approximation to Price VaR and Price VaR for a portfolio of US Treasury instruments. Then assuming a decline in market liquidity an adjusted VaR estimate is determined including an estimate of the loss amount attributed to market liquidity risk.

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