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Inputs/assumptions

Matrix math

Key portfolio calculations (marginal VaR, Inc'l VaR, Component VaR)

Portfolio inputs: A B

Position $100.00 $100.00

Volatility 10.00% 14.00%

Tot Portfolio $200.00

Correlation 0.20

Var-Covar 0.01 0

Matrix: 0 0.02

Portfolio

Variance (matrix) $352.00

Variance (alt) $352.00

Volatility $18.76

Volatility (alt.) $18.76

VaR $43.65

Individual Positions A B

Positions $100.00 $100.00

Volatility 10.00% 14.00%

(sigma)(X) 1.28 2.24

Individual VaR $23.26 $32.57

Beta 0.727 1.273

Marginal VaR 0.159 0.278

Marginal VaR 0.159 0.278

Incremental Position A B

+/- Position $0.010 $0.000

(x Marg'l VaR) 0.00159 0.0000

Incremetal VaR 0.00159 0.00000

Percent Contrib. 36% 64%

Question:

Assume a $200 t

has volatility of 1

Confidence 99.00%

(i) What is portfo

Critical z 2.33 (ii) What is portfo

(iii) What are the

Matrix math: (iv) What is the i

(v) What are the

Positions (x') Var-Covar Matrix (sigma) Positions (x) (vi) If correlation

$100.00 $100.00 0.01 0 $100.00

Answer:

0 0.02 $100.00

(i)

Kudos if you can

Positions (x') (sigma)(x) x'(sigma)x Variance = ($100

$100.00 $100.00 1.28 $352.00 Volatility = SQRT

Or, you can use

2.24

Volatility = SQRT

(9.38%)($200) =

2.24 2.24 No difference!

With 99%, the no

Diversified VaR =

This is a relative

(iii)

($100)(10%)(2.3

($100)(14%)(2.3

(iv)

The incremental

Assuming the ma

approximate incr

But please note

between Portfolio

(v)

$43.65

First, we want th

But, given that th

Marginal VaR = P

Asset #1 Margin

Asset #2 Margin

Component VaR

Asset #1 Compo

Asset #2 Compo

Percentage contr

Asset #1 Compo

Asset #2 Compo

(vi)

If correlation = 1

But for imperfect

Component VaR

Asset #1 Compo

Asset #2 Compo

Percentage contr

Asset #1 Compo

Asset #2 Compo

(vi)

If correlation = 1

But for imperfect

Sum of compone

Question:

Assume a $200 two-asset portfolio with equal positions in both assets ($100 + $100). Asset #1 has vo

has volatility of 14%. Their correlation is 20%. Our desired confidence is 99%.

(i) What is portfolio volatility?

(ii) What is portfolio VaR and diversified VaR and what is the difference?

(iii) What are the individual VaRs?

(iv) What is the incremental VaR?

(v) What are the component VaRs and percentage contributions?

(vi) If correlation is perfect (1.0), how will portfolio VaR compare to individual VaRs?

Answer:

(i)

Kudos if you can use matrix math to derive (see XLS). But also,

Variance = ($100^2)(10%^2)+($100^2)(14%^2)+(2)($100)($100)(0.20)(10%)(14%) = 352

Volatility = SQRT(352) = $18.8

Or, you can use percentage weights instead of dollar positions:

Volatility = SQRT[(50%^2)(10%^2)+(50%^2)(14%^2)+(2)(50%)(50%)(0.20)(10%)(14%)] = 9.38%

(9.38%)($200) = $18.8

(ii)

No difference!

With 99%, the normal deviate = NORMSINV(99%) = 2.33

Diversified VaR = (2.33)($18.8) = $43.6

This is a relative VaR. No expected returns are given and expected return is not netted, which would b

(iii)

($100)(10%)(2.33) = $23.26, and

($100)(14%)(2.33) = $32.57

(iv)

The incremental VaR can be approximated with: marginal VaR * trade.

Assuming the marginal VaR = 0.159 (see next), and the trade is +$10, then

approximate incremental VaR = (10)(0.159) = $1.59

But please note that using the marginal VaR is only an approximation. The true incremental VaR is giv

between Portfolio VaR (before trade) - Portfolio VaR (after trade)

(v)

First, we want the marginal VaR. Note in XLS we can get this two ways.

But, given that the betas are, respectively, 0.727 and 1.273,

Marginal VaR = Portfolio VaR/Portfolio Value * beta. In this case,

Asset #1 Marginal VaR = $43.6/$200 * 0.727 beta = 0.159

Asset #2 Marginal VaR = $43.6/$200 * 1.273 beta = 0.278

Component VaR = Position * Marginal VaR. In this case,

Asset #1 Component VaR = (0.159)($100) = $15.87

Asset #2 Component VaR = (0.278)($100) = $27.77

Percentage contributions are:

Asset #1 Component VaR % = $15.87/$43.6 = 36%

Asset #2 Component VaR = $27.77/43.6 = 64%

(vi)

If correlation = 1.0, sum of individual VaRs will EQUAL portfolio VaR.

But for imperfect correlation (rho < 1), sum of individual VaRs will be GREATER THAN portfolio VaR.

Component VaR = Position * Marginal VaR. In this case,

Asset #1 Component VaR = (0.159)($100) = $15.87

Asset #2 Component VaR = (0.278)($100) = $27.77

Percentage contributions are:

Asset #1 Component VaR % = $15.87/$43.6 = 36%

Asset #2 Component VaR = $27.77/43.6 = 64%

(vi)

If correlation = 1.0, sum of individual VaRs will EQUAL portfolio VaR.

But for imperfect correlation (rho < 1), sum of individual VaRs will be GREATER THAN portfolio VaR.

Sum of component VaRs, by definition, will be EQUAL to portfolio VaR.

100). Asset #1 has volatility of 10%, Asset #2

s?

14%) = 352

%)(14%)] = 9.38%

HAN portfolio VaR.

A B C D Port

0.61% 0.20% 0.24% 0.64% 0.42%

0.02% 0.58% -0.30% 0.40% 0.18%

1.00% 1.45% 1.15% 2.15% 1.44%

1.55% 1.73% 1.76% 0.99% 1.51%

1.94% 1.87% 1.70% 0.89% 1.60%

1.85% 0.58% 0.54% 1.53% 1.12%

0.13% 0.52% 0.46% 0.30% 0.35%

0.82% 0.55% 0.53% 0.04% 0.48%

0.75% 1.30% 0.95% 1.13% 1.03%

2.05% 0.63% 1.15% 1.27% 1.27%

0.60% 0.76% 0.53% 0.60% 0.62%

0.82% 1.12% 0.33% 1.04% 0.83%

-3.70% -1.72% -1.67% -1.78% -2.22%

2.17% 2.22% 1.76% 3.09% 2.31%

1.24% 2.37% 1.91% 2.38% 1.98%

-0.83% 0.17% -0.55% 1.02% -0.05%

-1.00% 0.15% 0.41% 0.91% 0.12%

-1.11% -1.85% -1.69% -0.26% -1.23%

1.57% 1.45% 1.44% 2.76% 1.80%

-1.66% -0.81% -1.84% -1.07% -1.35%

-0.29% -0.10% 0.24% 0.26% 0.03%

0.77% 0.88% 1.28% 1.74% 1.17%

0.54% 0.32% 0.73% 0.93% 0.63%

-1.43% -2.26% -3.08% -1.66% -2.11%

-0.83% -0.73% -1.89% 0.12% -0.83%

-5.75% -2.44% -2.25% -3.18% -3.41%

-5.61% -5.37% -4.22% -1.48% -4.17%

-1.44% -1.88% -1.58% 1.85% -0.76%

-0.06% 0.63% 0.26% -0.14% 0.17%

2.21% 0.00% -0.37% 2.43% 1.07%

0.48% -1.08% -0.79% 0.70% -0.17%

-0.52% 0.19% -0.26% -0.04% -0.15%

1.62% 0.14% 0.51% -0.30% 0.49%

2.27% 1.37% 1.80% 2.10% 1.88%

0.31% 0.28% -0.38% 0.35% 0.14%

1.54% 1.30% 1.16% 0.28% 1.07%

Std Dev 1.94% 1.54% 1.47% 1.34% 1.46%

Skew -1.60 -1.48 -0.97 -0.60 -1.27

Kurt 2.86 3.39 0.67 0.82 1.73

VarCovarMat

0.000365 0.000246 0.000233 0.000198

0.000246 0.000231 0.000208 0.000140

0.000233 0.000208 0.000210 0.000138

0.000198 0.000140 0.000138 0.000175

CorrelMat

1.00000 0.84911 0.83976 0.78304

0.84911 1.00000 0.94580 0.69716

0.83976 0.94580 1.00000 0.72100

0.78304 0.69716 0.72100 1.00000

Total

Weights 25% 25% 25% 25% 100%

Position 100 100 100 100 400

Sample Population

Port Mean 0.20%

Port Vol 1.46% 1.44%

Port Vol 5.8324 TRUE 5.7508 5.8324

Variance 34.017 33.07

Port VaR ( Raw ) 13.568 13.38 13.568

Port VaR ( Rel ) -3.1900%

Vol (Sample ) 1.94% 1.54% 1.47% 1.34%

Sigma (x) 0.1 0.08 0.08 0.07

CL 99.00%

Z-Score 2.33

CF Mod 0.73

Slope 1.26 1.00 0.95 0.79

Beta 1.26 1.00 0.95 0.79

Marginal VaR 0.0427 0.0339 0.0324 0.0267 0.13568

Marginal VaR 0.0427 0.0339 0.0324 0.0267 0.13568

31% 25% 24% 20% TRUE

Increment 133.333 133.333 133.333 0 400

Incremetal VaR 5.6963 4.5153 4.3181 0.0000 14.530

-3.4304%

Modified

0 0 0 0 0.00069 0.00039 0.00041

0 0 0 0 0.00039 0.00049 0.00034

0 0 0 0 0.00041 0.00034 0.00031

0 0 0 0 0.00034 0.00022 0.00027

Modified

1.00000 0.84911 0.83976 0.78304 1.0000 0.6749 0.8796

0.84911 1.00000 0.94580 0.69716 0.6749 1.0000 0.8778

0.83976 0.94580 1.00000 0.72100 0.8796 0.8778 1.0000

0.78304 0.69716 0.72100 1.00000 0.8141 0.6282 0.9519

Sample Population

1.92% 1.89%

7.6695 7.5622

58.821 57.187

17.84 17.84182 17.592

-4.2584% -4.2584%

1.94% 1.54% 1.47% 1.34% 2.67% 2.24% 1.80%

TRUE TRUE TRUE TRUE 0.18 0.14 0.13

6.2138 5.2082 4.1799

6.2138 5.2082 4.1799

0.0574 0.0451 0.0417

0.0574 0.0451 0.0417

32% 25% 23%

133.333 133.333 133.333

7.6560 6.0131 5.5666

0.00034

0.00022

0.00027

0.00026

0.8141

0.6282

0.9519

1.0000

1.60%

1.63%

0.11

0.4960

3.7857

3.7857

0.77

0.0342 0.178418

0.0342 0.178418

3.4151 17.84182

19%

0% 100%

0.000 400

0.0000 19.2357

-4.6069%

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