In todays video we will learn about some of the problems in Value at Risk.
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In todays video we will learn about some problems with Value at Risk (VaR) Calculations.
One of the first issues with VaR is that there is no standard protocol for the statistics used to determine asset, portfolio or firm-wide risk. For example, statistics calculated using a period of low volatility may understate the potential for risk events to occur and the magnitude of those events. Risk may be further understated using normal distribution probabilities, which rarely account for extreme events.
The assessment of potential loss represents the lowest amount of risk in a range of outcomes. For example, a VaR determination of 95% with 20% asset risk represents an expectation of losing at least 20% one of every 20 days on average. In this calculation, a loss of 50% still validates the risk assessment.
The financial crisis of 2008 exposed these problems as the relatively benign VaR calculations ended up understating the risk posed by portfolios of subprime mortgages. Risk magnitude was also underestimated, which resulted in extreme leverage ratios within subprime portfolios. As a result, the underestimations left institutions unable to cover billions of dollars in losses as subprime mortgage values collapsed.
Watch the video for more information.
