Illustrate the difference between the value-at-risk (VaR) and conditional value-at-risk (C-VaR) measures

Expert Solution

VaR is the amount of loss possible for given period at certain confidence level. VaR doesn’t quantifies the magnitude of worst loss which portfolio can experience in worst scenarios.

VaR is a single value which is calculated at particular confidence level for a period.

VaR = - Mean return + Standard deviation of return for period x Z-Value

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Conditional VaR is average of VaR at increasing confidence level. It is also called expected shortfall. The average of VaR at increasing confidence level after a specified confidence level give a good estimation of the losses which portfolio can experience in extreme scenarios.

Conditional VaR is average of VaR at increasing confidence level in tail.

Conditional VaR at 95% confidence would mean:

C-VaR = Average of (VaR at 97.5% + VaR at 99% + VaR at 99.99%)

C-VaR or Expected shortfall overcomes the limitation of normal VaR hence, it is preferred over normal VaR.

jeff jeffy answered 2 years ago

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