Sam Sez

Date: September 13, 1998

Question: "How Far with VAR (Value at Risk)"

Answer: Value at Risk (VAR) does not go very far when you need proactive risk management. VAR is essentially a historically driven approach which hopes that the markets conform to statistical normalcy despite quantitative evidence to the contrary.

Value at Risk exhibits the following characteristics.

STRENGTHS:

  • Good starting point for Risk Quantification
  • Standardized Methodology
  • Adaptable when properly modified and applied

WEAKNESSES:

  • Depends on Normalcy - Not Fat Tails
  • Assumes Independence of Returns
  • Expects Markets to Conform to Model Design

The methodology breaks down when times are turbulent. Can you afford to rely on VAR by itself?

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