Understanding Value at Risk (VaR) in Portfolio Management

In the context of portfolio management, Value at Risk (VaR) is a widely used risk management tool that quantifies the potential loss in value of a portfolio over a defined period for a given confidence interval. VaR is used by financial institutions to assess the magnitude of possible losses that could occur under normal market conditions.

If a portfolio has a daily VaR of $1 million at a 95% confidence level, it means that there is a 95% chance that the portfolio will not lose more than $1 million in a single day. However, it also implies a 5% chance that losses could exceed this amount. Understanding the limitations and applications of VaR is crucial for managing risks associated with investment portfolios.