Created more than a century ago by the actuaries to calculate the probability of bankrupt or the stocks of solvency, the value-at-risk is a widely used risk measure of the loss on a specific portfolio of financial assets. Until the late 80’s, the methods used to detect and manage risks were adapted to specific products; it was impossible to compare the risk measures between the different “tables” of the same trading floor. Thanks to the value-at-risk and its generalisation in the different markets worldwide, we can now define the “amount at risk” of a portfolio in one figure. But if this indicator has merits, it also has some limitations that we have to highlight in the aim to help managers and financial firms in their allocation and use of capital. Firstly, we will have a better look at what is value-at-risk, we will then discuss the merits and the limitations of this indicator.
La VAR
Definition
We will start with an example of the usefulness of the value-at-risk. If you decide to invest your money and become a shareholder, you will want to know what is happening with your money. If the advisor tells you that you have lost money, you will want to know how much money you are going to lose at the end of the month. The most correct answer he can give you is that you will lose everything but you will want precise information. The best and professional answer he can give you is “In the absence of exceptional events, there is a 95% chance that the portfolio split up or he lost 4,000 Euros or less by the end of the month”. This is where the value-at-risk indicator comes into play.
Value-at-risk of a portfolio of financial assets is the amount of loss that could not be exceeded over a given amount of time, if adverse events ("worst case scenarios") are excluded, which have a low probability of occurring. The value-at-risk is in an operational way an important and very widespread tool in the management of market risks. It represents a level of short-term loss that is