Calculating Value at Risk (VaR) TOC

CALCULATINGVALUEATRISK ByJawwadAhmedFarid

C A L C U L A T I N G  V A L U E A T  R IS K

CONTENTS

CALCULATINGVALUEATRISK.......................................................................................................................4 1.

INTRODUCTION..................................................................................................................................4

2.

VAR METHODS..................................................................................................................................5

a.

VarianceCovarianceApproach.........................................................................................................6

b.

HistoricalSimulationMethod............................................................................................................7

c.

MonteCarloSimulation.....................................................................................................................7

d.

QuickReview...................................................................................................................................... ............................................................................................................ ..........................8

e.

ImplementingVaR..............................................................................................................................8

3.

METHODOLOGY.................................................................................................................................8

a.

SettingtheScene................................................................................................................................ ............................................................................................................................. ...8 SamplePortfolio............................................................................................................................ ........................................................................................................................ ....8

b.

Preliminarysteps...............................................................................................................................9

c.

VaRApproachSpecificSteps..............................................................................................................12 Variance-Covariance(VCV)VaR....................................................................................................12 DeterminingHistoricalSimulationdailyVaR................................................................................14

d.

ScalingofthedailyVaR......................................................................................................................15

4.

UALIFICATIONS , LIMITATIONSANDISSUES................................................................................15 CAVEATS , Q UALIFICATIONS

5.

CASESTUDY –  – RISKFORTHE OILANDPETROCHEMICAL INDUSTRY.................................................................17

a.

AFrameworkforRiskManageme nt...................................................................................................17 ...................................................................................................17

b.

RiskPolicy........................................................................................................................................... .................................................................................................................. .........................18 18

c.

GoodDataandaFirstLookatModels...............................................................................................19

d.

ModelsandTools...............................................................................................................................20

e.

MetricsandSensitivities....................................................................................................................24

f.

LimitsandControlProcess..................................................................................................................27 Operational(ExceptionorManagementAction)Limits................................................................28 Operational(ExceptionorManagementAction)Limits ................................................................28 CapitalLoss&StopLossLimits.....................................................................................................28 InventoryAgeLimits.....................................................................................................................28 ConcentrationLimits.....................................................................................................................28 TransactionLimits.........................................................................................................................28 ExposureandSensitivityLimits.....................................................................................................28 Pre-SettlementRisk(PSR)andPotentialFutureExposure(PFE)Limits........................................28 HierarchyofLimits........................................................................................................................29

g.

Conclusion..........................................................................................................................................30

BIBLIOGRAPHY ..........................................................................................................................................31 DISCLAIMER ....................... ...................... ...................... ....................... ...................... ...................... ........32

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C A L C U L A T I N G  V A L U E A T  R IS K

BIBLIOGRAPHY 1. UnderstandingMarket,CreditandOperationalRisk-TheValueatRiskApproach,LindaAllen, JacobBoudoukhandAnthonySaunders,BlackwellPublishing,2004 2. BeyondValueatRisk,TheNewScienceofRiskManagement,KevinDowd,JohnWiley& Sons,1998 3. Higher-OrderSimulations:StrategicInvestmentUnderModel-InducedPricePatterns,Gilbert PefferandBàrbaraLlacay,JournalofArtificialSocietiesandSocialSimulationvol.10,no.2,6 ,2007 4. TheBlackSwan,theimpactofthehighlyimprobable,NassimNicholasTaleb,Random House,2007 nd 5. RiskFrameworksandApplications-2 Edition,JawwadA.Farid,2011

Pleasedonotphotocopyordistributewithoutpermission.AllrightsreservedAlchemySoftwarePvtLimited. http://FourQuants.com Page31of32