We cover how to estimate Value at Risk (VaR). VaR is one of the most important risk measures in financial markets and it can be interpreted as a minimum loss that would be expected to occur over a given period of time. It can be measured either in currency units or percentage terms. There are three commonly used methods for estimating VaR: the parametric or variance-covariance method, the historical method and the Monte Carlo method. Today, we will cover the parametric or variance covariance method which estimates VaR based the expected return and standard deviation of returns. This method works well when one is confident that the normal distribution can be applied. It is less useful when applied to an investment portfolio containing options as this leads to non-normal distributions.
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