Value At Risk (VaR)

VaR is a measure of market risk. It is the measure of maximum loss that can occur with certain confidence interval over a given period of time. Using VaR, financial institutions can determine the sufficient capital reserves in place they need to cover losses or whether higher than acceptable risk holdings need to be reduced. VaR is advantageous in the sense that it is easy to understand and captures the aspect of risk in a single number.

For example, value at risk of $10 million for 1 month for 5% significance level means that there is a 5% probability that the value of the portfolio will fall by more than $10 million in 1 month. Other way, it can be interpreted that there is 95% probability that 1-month loss will not be more than $10 million.