Market Risk and Var Models 4: Applications, limits

Question 1

What are the main applications of VaR Models?

Answer 1

1. Creating a common risk language
2. Estimating risk-adjusted performance (RAP)
3. Setting risk limits
4. Risk-Adjusted Pricing

Question 2

What are the fomulas for risk-adjusted performance?

Answer 2

RAROC_ex-ante=E(P&L)/VaR
RAROC_ex-post=P&L/VaR

Question 3

What are some common critiques for VaR models?

Answer 3

1. VaR models do not consider exceptional events
2. VaR models do not consider customer relationships
3. VaR models are based on unrealistic assumptions
4. VaR models amplify markets instability
5. VaR models do not react quickly enough

Question 4

What is the most real VaR problem?

Answer 4

VaR does not consider the size of losses

Question 5

What is the solution to VaR not considering the size of losses?

Answer 5

Expected shortfall:
“the expected value of losses that the portfolio could suffer in the (1-c) worst case during the time horizon T”
VaR = E(P)-L_c
ES_c = E(P) - E(L|L>L_c)