4. Value-at-Risk and Conditional Value-at-Risk
Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR) are widely used measures of the risk of loss on an asset or portfolio of assets. These metrics measure the potential loss in value over a defined period for a given confidence interval.
The Securities and Exchange Commission (SEC) in 1980 began requiring financial services firms to estimate losses that might be incurred over a 30-day period with 95% confidence. The SEC wanted to make sure these firms were holding enough capital to cover potential losses. This required an estimate of probability distributions, usually calculated from historical data across asset classes. Capital requirements continue to evolve in regulations such as Basel II ...
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