Value at risk
The minimum loss expected over a set period with a given probability: a 5% one-day figure of $1m means a loss at least that large one day in twenty. It says nothing about how bad the tail gets.
Where you will meet it
Value at risk appears in 20 learning outcomes on the CFA syllabus. A few of them:
- Explain historical simulation and how it is used in investing
“Each past period becomes one scenario, and the resulting profits and losses form an empirical distribution from which value at risk, shortfall probabilities and stress results can be read.”
- Explain what risk tolerance and risk budgeting mean
“The budget can be expressed in standard deviation, value at risk or contribution to total risk, and the last is the most informative because it accounts for how positions interact rather than treating each in isolation.”
- Set out risk measures suited to return distributions that are not normal
“Downside deviation, the Sortino ratio, maximum drawdown and value at risk each address part of it by focusing on the loss side, though none is a complete substitute for understanding the strategy's payoff structure.”
- Explain the CAMELS approach to bank analysis, which covers capital adequacy, quality of assets, management, earnings, liquidity and sensitivity, with its main ratios and its limitations
“Sensitivity to market risk examines repricing gaps and value at risk.”
Practise it
Practise value at risk until it is automatic: questions that explain every wrong option.
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