In the schweser it says:
The percentage selected will affect the VaR. A 1%VaR would be expected to show greater risk than a 5% VaR.
Can anyone tell me does these percentages reflect probabilities? If yes then how can we interpret that whether this is a probability or not as in many examples it say 1.37% VaR at the 5% probability and likewise. If no then how 1%VaR could reflect a greater risk than 5%.
I hope I am clear in my question. Thanks
The reflect probabilities which correspond to confidence intervals of 95% and 99%. The 1% will reflect greater risk because you are assigning a 1 percent change that a given loss will be worse than the calculated VaR.
It helps to think of it in terms of confidence intervals.
Let’s say the following:
5% VaR = $1.5M
1% VaR = $3.0M
Now let’s frame in confidence intervals…There is a 95% probability that the loss will be less than $1.5m, conversely there is a 5% probability that loss will be at least $1.5M. There is a 99% probability that the loss will be less than $3.0m, conversely there is a 1% probability that the loss will be at least $3.0M
Thanks alot. But how do we figure out in the exam what they are referring to?
I’m not following your question… If you have a 1.37% Var at the 5% level and the portfolio is worth $100M then you would expect to at least $1.37M 5% of the time.