The Value At Risk Management - 1219 Words

Most people who have invested or are considering investing in any financial asset, ask at some point in time the following question: What is the most I can loose on my investment? The Value at Risk, commonly known as VaR, tries to answer this question within a reasonable bound. VaR is used in financial mathematics and financial risk management as a risk management tool to measure the risk of loss of an individual asset or a whole portfolio. Although it provides a good sense of risk one is undertaking, it shouldn’t be an alternative method to risk adjusted value and or other probabilistic approaches. In the following lines, we first give a general description of the VaR and the story behind its development and its applications. We then†¦show more content†¦Financial institutions, mostly commercials and investments banks, use the VAR to gauge the amount of cash they should hold in their reserve in order to be able to cover the potential loss. Although the term â€Å"Va lue at risk† has not been used till the1990s, the origins of its measure lie further back in time. The arithmetic behind the VaR were developed by Harry Markowitz (1952) in his studies of effects of asset risk, return, correlation, and diversification on probable investment portfolio returns which contributed to the modern portfolio theory. In fact, the trigger of the use of VaR came from the crisis that tormented the financial market and the regulatory responses to these crises. After the great depression of 1929, the Securities Exchange Act established in 1934 the Security Exchange Commission (SEC), a federal government agency in charge of regulating stocks and options exchanges. Since the SEC initially required banks to keep their borrowing below 2000% of their equity capital, Banks developed risk measures and control devices to ensure that they meet the capital requirements. In the 1970, the introduction of financial derivatives markets and floating rate exchanges have si gnificantly increased the volatility, which is the risk, in the financial markets. The latter was confirmed by the failure in 1995 of Barings, the British investment bank, by the unauthorized trading in Nikkei (Japan’s stock