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How much can I lose?

A brief look at Value-at-Risk David J. Moore, Ph.D.

www.efficientminds.com

April 3, 2014

5 steps to a number
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Compute the previous 500 daily returns (individual or portfolio). Compute the 5% daily volatility (vol ). You have a 5% chance of losing vol % or more in one day. Two approaches to vol :
Assume returns are normally distributed with mean µ and standard deviation σ : vol = µ − 1.65σ Make no distribution assumption: vol = 25th worst daily return

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Compute Daily Earnings at Risk (DEAR ): DEAR = current dollars invested · vol

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Assume daily volatility is constant and there is no√ autocorrelation. 2 2 Therefore σN = σ · N and σ = σ · N. N day 1 day day 1 day Compute the N day Value at Risk (VAR ). There is a 5% chance you could lose VAR dollars or more in the next N days. √ VAR = DEAR · N

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