Value at Risk (VaR) Calculator
Calculate the Value at Risk (VaR) for your investment portfolio. VaR estimates the maximum potential loss over a specific time period with a given confidence level.
Value at Risk Results
Risk Analysis
VaR Risk Levels
Low Risk: < 1% of portfolio
Moderate Risk: 1-3% of portfolio
High Risk: 3-5% of portfolio
Very High Risk: > 5% of portfolio
Note: Based on 95% confidence
Understanding Value at Risk (VaR)
Value at Risk (VaR) is a statistical technique used to measure the level of financial risk within a portfolio over a specific time frame. It estimates the maximum potential loss with a given confidence level.
VaR Formula
The parametric VaR formula is:
VaR = P × s × vt × Z
Where: P = portfolio value, s = volatility, t = time, Z = confidence factor
Confidence Levels
- 95% Confidence: 5% chance of loss exceeding VaR (most common)
- 99% Confidence: 1% chance of loss exceeding VaR (more conservative)
- 99.9% Confidence: 0.1% chance of loss exceeding VaR (extreme events)
- Higher Confidence: Means larger VaR (more conservative estimate)
VaR Methods
| Method | Description | Advantages | Limitations |
|---|---|---|---|
| Parametric | Uses normal distribution | Simple, fast calculation | Assumes normal returns |
| Historical | Uses actual historical data | No distribution assumptions | Limited by data availability |
| Monte Carlo | Simulates multiple scenarios | Handles complex portfolios | Computationally intensive |
Applications
- Risk Management: Set risk limits and monitor portfolio risk
- Capital Allocation: Determine required capital reserves
- Regulatory Compliance: Meet regulatory risk requirements
- Portfolio Optimization: Balance risk and return objectives
- Stress Testing: Evaluate portfolio under adverse conditions
Interpreting VaR
VaR tells you: "With X% confidence, my losses will not exceed Y amount over Z time period."
- Example: 95% VaR of $10,000 means 95% confident losses won't exceed $10,000
- Probability: There's still a 5% chance of larger losses
- Not Worst Case: Extreme events can cause larger losses
- Time Frame: Usually daily, but can be for any period
Limitations of VaR
- Tail Risk: Doesn't capture extreme events beyond the confidence level
- Assumptions: Relies on statistical assumptions about return distributions
- Liquidity Risk: Doesn't account for inability to sell assets
- Volatility Clustering: Assumes constant volatility
- Black Swan Events: Cannot predict unprecedented events
VaR vs. Other Risk Measures
- Standard Deviation: Measures volatility, not potential loss
- Sharpe Ratio: Risk-adjusted return, not maximum loss
- Expected Shortfall: Average loss beyond VaR (more conservative)
- Stress Testing: Evaluates specific adverse scenarios
Tip: VaR is a useful risk management tool, but it should not be the only measure used. Combine VaR with other risk metrics and stress testing for a comprehensive view of portfolio risk. Remember that VaR estimates potential losses, not guaranteed outcomes.