The Intuition and Methodology of Value at Risk‪.‬

Abstract Value at Risk (VaR) is the maximum dollar portfolio amount that can be lost in a given period of time with a specified level of confidence--usually 5%. VaR has become a valuable tool that financial managers can use to measure market risk. The three basic VaR methodologies are Historical, Parametric and Simulation VaRs. Each has advantages and limitations, as well as ease of application under varied circumstances. In theory, the three should generally give equal values and any differences in their computed values are attributable to modeling issues and violations of assumption. Trends in VaR should be noted and explained. More problematic than the actual number and/or differences in the number is the array of possible realizations during the "other 5% of the time." If the other 5% of the time is well behaved, then those realizations should be anticipated and easily dealt with. On the other hand, if the other 5% of the time is not well behaved, then those realizations could be catastrophic and could lead to the demise of the enterprise.