Strategic Risk Taking: A Framework for Risk Management

Chapter 7. Value at Risk (VaR)

What is the most I can lose on this investment? This is a question that almost every investor who has invested or is considering investing in a risky asset asks at some point in time. Value at risk (VaR) tries to provide an answer, at least within a reasonable bound. In fact, it is misleading to consider VaR to be an alternative to risk-adjusted value and probabilistic approaches. After all, it borrows liberally from both. However, the wide use of VaR as a tool for risk assessment—especially in financial service firms—and the extensive literature that has developed around it push us to dedicate this chapter to its examination.

We begin this chapter with a general description of VaR and the view of risk that underlies ...