Set out the ways VaR has been extended
The idea
Conditional VaR, also called expected shortfall or expected tail loss, is the average loss in outcomes worse than the VaR and is always at least as large as VaR at the same probability. Incremental VaR is the change in portfolio VaR from adding, removing or resizing a position: VaR after minus VaR before. Marginal VaR is the change in VaR per small change in a position's size, used to see which holdings drive risk. Relative VaR, closely related to ex ante tracking error, measures potential shortfall against a benchmark rather than in absolute terms. The trap is confusing a position's standalone VaR with its incremental VaR, which reflects diversification with the rest of the portfolio.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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- Explain how value at risk (VaR) is applied to gauge the risk of a portfolio
- Contrast three ways to estimate VaR: Monte Carlo simulation, historical simulation, and the parametric (variance–covariance) method
- Estimate VaR by Monte Carlo simulation, by historical simulation, and by the parametric method, and explain what each result means
- Set out the strengths and weaknesses of VaR
- Explain sensitivity and scenario risk measures and weigh them against VaR
- Show how exposure measures for equities, fixed income, and options can help gauge and control market risk and volatility risk
- Set out how sensitivity and scenario risk measures are applied
- Set out the strengths and weaknesses of sensitivity and scenario risk measures
- Explain the limits used to control market risk, among them stop-loss limits, scenario limits, position limits, and risk budgeting
- Explain how risk measures can guide decisions on allocating capital
- Set out the risk measures relied on by insurers, pension funds, asset managers, and banks