VaR Node
Value at Risk - maximum loss at confidence level
Overview
Value at Risk (VaR) is the maximum loss expected at a given confidence level over a time horizon. VaR 95% = "99 days out of 100, we won't lose more than this." VaR is the regulatory standard for bank capital requirements and internal risk management. It's the complement to CVaR: VaR is the threshold; CVaR is the average beyond that threshold.
VaR directly answers: "How much capital do I need to cover worst-case losses?" For traders, VaR -5% (95% confidence) means "one in 20 days could be worse than -5% loss." Combine with CVaR to understand severity of breaches.
Formula & Calculation
95% VaR = 5th percentile of returns
95%: Z = -1.645, 99%: Z = -2.326
Parameters
| Parameter | Default | Description |
|---|---|---|
| lookback | 252-504 | Historical window |
| confidence | 95% or 99% | Confidence level |
Common Use Cases
1. Capital Requirement
Banks/funds use VaR to set minimum capital: Capital = Portfolio Value × VaR(99%). Ensures survival of 1-in-100 days loss.
2. Position Limits
Set max position size: Position = Capital × Risk Appetite / VaR. If VaR = -5% and capital = $1M, max loss per trade = $50k.
3. Scenario Planning
Model stress scenarios: "If this position hits VaR 95%, am I bankrupt?" Identify concentration risks requiring hedges.
4. Regulatory Reporting
Daily VaR disclosure required for hedge funds/banks. Track VaR trend as risk indicator. Rising VaR = increasing portfolio risk.
Advantages & Limitations
Advantages
- Regulatory standard
- Single intuitive number
- Works across assets
- Enables capital planning
Limitations
- Ignores severity beyond threshold
- Assumes stationarity
- Backward looking
- Wrong in tail events