Understanding Value at Risk in Portfolio Management

Value at Risk (VaR) is a widely used risk management tool that measures the potential loss in value of an asset or portfolio over a defined period for a given confidence interval. Understanding VaR is crucial for portfolio managers to assess potential risks associated with different assets. Consider an investor who has calculated a portfolio's VaR at $1 million at a 95% confidence level over a 1-day holding period. This would imply that there is a 5% probability that the portfolio will incur a loss exceeding $1 million over the next day.

Which of the following statements about Value at Risk is correct?