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    Question

    Value at Risk (VaR) is a widely used risk management

    tool. A limitation of the VaR approach to measuring risk is that it fails to specify:
    A the probability that a loss could occur Correct Answer Incorrect Answer
    B a time frame for potential loss Correct Answer Incorrect Answer
    C the maximum loss that could occur Correct Answer Incorrect Answer
    D assumptions for estimation of loss Correct Answer Incorrect Answer
    E None of these Correct Answer Incorrect Answer

    Solution

    A limitation of the value at risk (VaR) approach to measuring risk is that it fails to specify the maximum loss that could occur. VAR statistic has three components - a relatively high level of confidence (typically either 95% or 99%), a time period (a day, a month or a year) and an estimate of investment loss (expressed either in absolute or percentage terms). However, at a 99% confidence level what VAR really means is that in 1% of cases (that would be 2-3 trading days in a year with daily VAR) the loss is expected to be greater than the VAR amount. Value At Risk does not say anything about the size of losses within this 1% of trading days and by no means does it say anything about the maximum possible loss.

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