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- qualifies the exposure of a pf to risk
- based on common risk horizon
- uses consistent basis to quantify risk ($) -> compare
- probability based: can derive loss at any degree of conf
Limitations of VaR
- should be used in conjunction w other methods
- Proctor & Gamble (swap): VaR not designed for single trans; P&G more concerned w CF risk
- Barings (rogue trader): mgt wasn't aware of trans
- Orange County (bet on yield): aware of risk, seeking profit
- Metallgesellschaft (LT price guarantee on gas & oil): trans were already hedged, problem was in CF
Alternatives to VaR (similar)
- CF risk: usefull when concerned on CF volatility
- Shortfall risk: determines prob associated w given shortfall. Penalizes more big shortfalls than smaller ones.