Value at Risk (VaR)
The maximum loss not expected to be exceeded over a given time horizon at a chosen confidence level, e.g. 95% or 99%.
Formula
Parametric VaR = Portfolio Value × Z-score × Daily Volatility
Value at Risk (VaR) estimates the worst probable loss on a portfolio over a specific time period at a given confidence level. A 1-day 95% VaR of $1,000 means there is a 5% chance of losing more than $1,000 in a single day.
VaR is widely used in institutional risk management but has important limitations: it says nothing about the size of losses beyond the threshold (tail risk), and it tends to understate risk in market crises when correlations spike.
- Parametric VaR assumes normally distributed returns — dangerously wrong in fat-tailed markets.
- Historical VaR replays actual past returns — better, but blind to new regimes.
Related Terms
Black Swan
An extreme, unpredictable, high-impact event that falls outside the range of normal expectations and is rationalised as predictable only in hindsight.
IntermediateConditional Value at Risk (CVaR)
The average loss in the worst-case tail beyond the VaR threshold; it answers how bad losses are when VaR is breached, not just how often.
AdvancedCorrelation
A measure of how closely two assets move together, ranging from −1 (perfectly opposite) to +1 (perfectly in sync).
IntermediateHedging
Opening an offsetting position to reduce the net risk of an existing trade or portfolio against adverse price movements.
IntermediateSharpe Ratio
Return per unit of total risk — how much reward you earn for each unit of volatility taken. Higher is better.
IntermediateTail Risk
The risk of rare, extreme outcomes in the far ends of a return distribution — events that standard models greatly underestimate.
Advanced