Understanding the Implications of VaR

Easy Risk Management Applications Value At Risk

Value at Risk (VaR) is a widely used risk management tool that estimates the potential loss in value of a portfolio over a defined period for a given confidence interval. For instance, a 1-day VaR of $1 million at a 95% confidence level indicates that there is only a 5% chance that the portfolio will lose more than $1 million in one day.

Consider a hedge fund that reports a VaR of $2 million at a 99% confidence level for a one-month investment horizon. This implies that the fund aims to ensure that, with 99% confidence, the portfolio will not lose more than $2 million over the next month.

Based on this information regarding VaR, which of the following statements is true?

VaR indicates the maximum potential loss that will not be exceeded 99% of the time.

VaR measures the average loss expected in the worst-case scenarios.

Higher VaR values indicate lower portfolio risk.

Hint

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