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Value at Risk (VaR)

Value at Risk (VaR) is a risk management tool that estimates the maximum potential loss of a portfolio or investment over a specific time period with a given confidence level. VaR is commonly used to assess market risk and helps investors or institutions understand the potential downside of their positions. It is typically expressed as a dollar amount or percentage and assumes normal market conditions.

Example

A portfolio with a one-day VaR of $1 million at a 95% confidence level means that there is a 95% probability that the portfolio will not lose more than $1 million in one day under normal market conditions.

Key points

• A metric that estimates the maximum potential loss of an investment over a set period at a given confidence level.

• Commonly used for risk management in financial institutions and investment portfolios.

• Assumes normal market conditions and helps investors understand downside risk.

Quick Answers to Curious Questions

VaR helps investors quantify the potential downside risk of their investments and estimate the maximum possible loss within a specific time frame.

VaR assumes normal market conditions and may underestimate risks during extreme events or periods of market instability.

VaR is expressed as a dollar amount or percentage, along with a confidence level and a specific time horizon (e.g., 95% VaR over one day).
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