Corporate Risk Management

CHAPTER 5Value at Risk

The main role of value at risk (VaR) is to provide summary information on the risk of a firm, a portfolio, or a stock. This information is generally given to a firm's top management or to a portfolio manager or stockholder. It may also be used by regulatory agencies.

Some managers wish to be informed of their firm's VaR at 4:30 p.m. daily, while others would rather be given this information on Friday afternoons. Regulatory agencies require the banks that calculate their market risk using an internal method to transmit their market VaR every two weeks (or 10 business days). However, market risk VaR is now replaced by CVaR for Basel market risk regulation. This does not mean that the VaR is becoming useless. In fact, it is still very useful for backtesting the CVaR (Fortin, Simonato, and Dionne, 2018).

VaR is the maximum loss calculated for a given time period at a certain confidence level. It contains a time component (intraday, daily, weekly, monthly, or even annually for credit risk), and takes into account the opinion of a firm's management or of a portfolio holder to set the confidence level. The more conservative the opinion, the greater the required confidence level and the higher the VaR.

For many years, VaR was the most popular method used to measure market risk. However, this measurement focuses on the minimization of variance, which contradicts the model suggested in Stulz's (1996) article. Stulz suggests that we should instead focus on minimizing ...