Should VAR include mean return?

Discussion in 'P1.T4. Valuation & Risk Models (30%)' started by qin841121, May 13, 2012.

  1. qin841121

    qin841121 Member

    John Flag, the manager of a USD 150 million distressed bond portfolio, conducts stress tests on the portfolio. The portfolio's annualized return is 12%, with an annualized return volatility of 25%. In the past two years, the portfolio encountered several days when the daily value change of the portfolio was more than 3 standard deviations. If the portfolio would suffer a 4-sigma daily event, estimate the change in the value of this portfolio.

    Daily volatility is equal to 0.25 * sqrt (1/250) = 0.0158. A 4-sigma event therefore implies a loss equal to 4*0.0158*150 = 9,486,832

    Why it shouldn't be (.12-0.25) * sqrt (1/250)?
  2. Aleksander Hansen

    Aleksander Hansen Well-Known Member

    Relative VaR & Absolute VaR
    One has drift, the other does not.
    Depends on application but usually use relative VaR, especially when horizon is short.
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  3. qin841121

    qin841121 Member

    Thanks a lot!
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