Impact of Changing Confidence Level on VaR

Medium Risk Management Applications Value At Risk

ABC Asset Management is evaluating its risk exposure in an equity portfolio. The risk manager has calculated a one-day Value at Risk (VaR) of $1 million at a 95% confidence level. This means that, over a one-day horizon, there is a 95% probability that the portfolio will not lose more than $1 million. However, after reviewing historical performance, the risk manager questions whether this VaR estimate accurately reflects potential losses during extreme market conditions.

To further analyze the portfolio's risk profile, the risk manager considers adjusting the confidence level to assess the potential losses at different thresholds. The manager wonders how changing the confidence level will affect the VaR calculation and its interpretation.

Which of the following statements best describes the impact of increasing the confidence level on the calculated VaR?

Increasing the confidence level results in a higher VaR estimate, which indicates greater potential losses.

Increasing the confidence level will have no effect on the VaR estimate since VaR is independent of confidence levels.

Increasing the confidence level leads to a lower VaR estimate, suggesting reduced risk.

Hint

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