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Value-at-Risk
Value-at-Risk
Chapter 18
Options, Futures, and Other Derivatives 6th Edition, Copyright John C. Hull 2005 18.1
The Question Being Asked in VaR
vi
vm
vi 1
year
day
252
200,000 10 $632,456
50,000 10 $158,144
The VaR is
X Y 2X Y2 2 X Y
We assume
The daily change in the value of a portfolio
is linearly related to the daily returns from
market variables
The returns from the market variables are
normally distributed
n
P i xi
i 1
n n
P2 i j i j ij
i 1 j 1
n
P2 i2 i2 2 i j i j ij
i 1 i j
10,000
6.5
6,540
1.0675
in 5 years6,and
540 by
0.926 $6,056
in 7 years.
This cash flow mapping preserves
value and variance
Options, Futures, and Other Derivatives 6th Edition, 18.25
When Linear Model Can be Used
Portfolio of stocks
Portfolio of bonds
Interest-rate swap
2
this becomes
1 2
P S x S (x) 2
2
Calculate P
Repeat many times to build up a
probability distribution for P
VaR is the appropriate fractile of the
distribution times square root of N
For example, with 1,000 trial the 1
percentile is the 10th worst case.
1 yr 2 yr 3 yr 4 yr 5 yr
+10 +4 -8 -7 +2