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Risk Measurement: An Introduction to Value at Risk

Author

Listed:
  • Thomas J. Linsmeier

    (University of Illinois at Urbana-Champaign)

  • Neil D. Pearson

    (University of Illinois at Urbana-Champaign)

Abstract

This paper is a self-contained introduction to the concept and methodology of "value at risk," which is a new tool for measuring an entity's exposure to market risk. We explain the concept of value at risk, and then describe in detail the three methods for computing it: historical simulation; the variance-covariance method; and Monte Carlo or stochastic simulation. We then discuss the advantages and disadvantages of the three methods for computing value at risk. Finally, we briefly describe some alternative measures of market risk.

Suggested Citation

  • Thomas J. Linsmeier & Neil D. Pearson, 1996. "Risk Measurement: An Introduction to Value at Risk," Finance 9609004, EconWPA.
  • Handle: RePEc:wpa:wuwpfi:9609004
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    Citations

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    Cited by:

    1. Ender Su & Thomas W. Knowles, 2006. "Asian Pacific Stock Market Volatility Modeling and Value at Risk Analysis," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 42(2), pages 18-62, April.
    2. Kaplanski, Guy & Kroll, Yoram, 2002. "VaR Risk Measures versus Traditional Risk Measures: an Analysis and Survey," MPRA Paper 80070, University Library of Munich, Germany.
    3. Qi Tang & Danni Yan, 2010. "Autoregressive trending risk function and exhaustion in random asset price movement," Journal of Time Series Analysis, Wiley Blackwell, vol. 31(6), pages 465-470, November.
    4. Wallace, Garry E. & Samsul Huda, A.K., 2005. "Using climate information to approximate the value at risk of a forward contracted canola crop," AFBM Journal, Australasian Farm Business Management Network, vol. 2(1).
    5. Rossignolo, Adrián F. & Fethi, Meryem Duygun & Shaban, Mohamed, 2013. "Market crises and Basel capital requirements: Could Basel III have been different? Evidence from Portugal, Ireland, Greece and Spain (PIGS)," Journal of Banking & Finance, Elsevier, vol. 37(5), pages 1323-1339.
    6. Mark R. Manfredo. & Raymond M. Leuthold, 1999. "Market Risk Measurement and the Cattle Feeding Margin: An Application of Value-at-Risk," Finance 9908002, EconWPA.
    7. Marcello Spanò, 2013. "Theoretical explanations of corporate hedging," International Journal of Business and Social Research, MIR Center for Socio-Economic Research, vol. 3(7), pages 84-102, July.
    8. Basak, Suleyman & Shapiro, Alexander, 2001. "Value-at-Risk-Based Risk Management: Optimal Policies and Asset Prices," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 371-405.
    9. Elizabeth Anne Yeager & Michael R. Langemeier, 2013. "Economic efficiency and downside risk," Applied Economics, Taylor & Francis Journals, vol. 45(36), pages 5012-5020, December.
    10. Mark R. Manfredo & Raymond M. Leuthold, 1998. "Agricultural Applications of Value-at-Risk Analysis: A Perspective," Finance 9805002, EconWPA.
    11. Cohen, Morrel H. & Natoli, Vincent D., 2003. "Risk and utility in portfolio optimization," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 324(1), pages 81-88.
    12. Ender Su & Thomas W. Knowles, 2006. "Asian Pacific Stock Market Volatility Modeling and Value at Risk Analysis," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 42(2), pages 18-62, April.
    13. Rossignolo, Adrian F. & Fethi, Meryem Duygun & Shaban, Mohamed, 2012. "Value-at-Risk models and Basel capital charges," Journal of Financial Stability, Elsevier, vol. 8(4), pages 303-319.
    14. Rifki Ismal, 2010. "Volatility of the returns and expected losses of Islamic bank financing," International Journal of Islamic and Middle Eastern Finance and Management, Emerald Group Publishing, vol. 3(3), pages 267-279, August.
    15. Xiongwei Ju & Neil D. Pearson, 1998. "Using Value-at-Risk to Control Risk Taking: How Wrong Can you Be?," Finance 9810002, EconWPA.
    16. Javier Calatrava & Alberto Garrido, 2005. "Spot water markets and risk in water supply," Agricultural Economics, International Association of Agricultural Economists, vol. 33(2), pages 131-143, September.
    17. Yass A. Alkafaji & Nauzer Balsara & Judith N. Aburmishan, 2006. "FASB’s Statement No. 133 on Derivatives and Barings Bank: The Case for Value at Risk (VAR)," Accounting Research Journal, Emerald Group Publishing, vol. 19(2), pages 94-104, September.
    18. Billio, Monica & Pelizzon, Loriana, 2000. "Value-at-Risk: a multivariate switching regime approach," Journal of Empirical Finance, Elsevier, vol. 7(5), pages 531-554, December.
    19. Amita Sharma & Sebastian Utz & Aparna Mehra, 2017. "Omega-CVaR portfolio optimization and its worst case analysis," OR Spectrum: Quantitative Approaches in Management, Springer;Gesellschaft für Operations Research e.V., vol. 39(2), pages 505-539, March.
    20. Karoline Terán Matamoros & Oscar Molina Tejerina, 2005. "Simulación eficiente del valor de riesgo de un portafolio de acciones del IPSA: Un análisis de componentes principales," Investigación & Desarrollo 0205, Universidad Privada Boliviana, revised Mar 2005.

    More about this item

    Keywords

    subliminal extant Smith economagic gmm value at risk; market risk; simulation;

    JEL classification:

    • G - Financial Economics

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