Jul 23

Value at Risk (VaR): Hybrid Approach – 8 min screencast

by David Harper, CFA, FRM, CIPM

FRM |

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Yesterday I illustrated the simple historical approach to estimating value at risk (VaR). Today, using the same 100-day sample of Google's recent daily (periodic) stock returns, I illustrate the hybrid approach. The key idea is

  • Under the simple, each daily return gets the same weight (1%)
  • Under the hybrid, more recent returns get greater weight (in this example, with lambda of 97%, following RiskMetrics, the most recent weight is 1-97% or fully 3%).

So, if my goal is a 95% confidence VaR, then under the hybrid approach, I reach the 5th percentile (in the case) among the sorted returns at about –4.7% instead of at about –4.1% (I have omitted interpolation to focus on the idea):

hybrid_thm

Screencast:

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