Question

Compare and contrast the 3 methods of calculating Value at Risk (VaR)

Answer 1

Three methods of calculating value at risk are Historical method,Variance-Covariance method and the Monte Carlo simulation.

i) Historical method is based on reorganization of historical returns in order from wrost to best.This methods assumes that risk will be based on the past or historical values.

ii) Variance - Covariance method assumes that returns are normally distributed.We calculate expected return and standard deviation and plot it in the normal distribution curve.Variance-Covariance method is similar to historical method except that we use familiar curve instead of actual curve and we know we're the worst would lie on the curve.

iii) Monte Carlo Simulation :- It involves developing a model for the ascertainment of future stock prices and their returns and running multiple hypothetical trial through the model.It randomly generates trials without any underlying technology.

VAR calcultes the maximum loss expected on a Investment.We use three different method the first two will calculate the daily VAR however the third one will calculate the monthly VAR.