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#FRM:Important Topics to Remember Before FRM-I Exam
- 13. Value at Risk
In this session, we will share with you Tips on ‘Value at Risk’
1.
VaR represents maximum potential loss in value of a portfolio of financial instruments with a given probability over
a certain time horizon. VAR Z X % * * Asset Value
2.
VaR for a portfolio has similar concept as standard deviation for a portfolio has:
VaR portfolio (in %) wa2 (%VAR a ) 2 w 2 (%VAR b ) 2 2w a w b * (%VAR a ) * (%VAR b ) * ab
b
3.
VaR can be measured with two methods: (i) Linear Valuation Method: a) Delta Normal Method (ii) Full Revaluation
Method (a) Historical Simulation (b) Monte Carlo Simulation
4.
Linear Valuation doesn’t work for portfolios of non‐linear securities
5.
There are two explanations for the Fat Tails: (i) Conditional Mean: Mean changing over the period of time (ii)
Conditional Volatility: Volatility changing over the period of time
6.
Full Revaluation Method accounts for non‐linearity of derivatives whereas delta normal assumes a linear
approximation. It is also important to understand that it accounts for extreme fluctuations
7.
You can expect at least 1 question on Historical Simulation. It has a benefit that there are no assumptions required
about the distribution of returns. It is not exposed to any model risk. The biggest drawback with the Historical
Simulation method is that the changes in volatility and correlation from structural changes are not recognized
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