This method takes three variables into account, and although it may seem complicated it is actually quite easy to understand. The three variables are time, probability of loss and the amount of that loss. Using this method, a company can estimate that there is a 5% chance of losing 2 million euros in a one-month time frame. In other words, there is a 5% probability that the company will lose 2 million euros in one month or another and a 95% probability that this loss will be less. As a result, the company must take into account the fact that it will lose 2 million euros in a certain month.
VaR, or Value at Risk, can be used to calculate the maximum loss of both a financial asset and a group of assets, and it is therefore widely used to measure and control the risk that a company can bear so that it doesn't take more risks than it can cope with. When a company makes an investment, it can compare its VaR with the estimated profits and decide to invest where there are higher returns while diversifying the risk.
can see this more clearly with an example. If the VaR of a particular portfolio is 5,000 euros, this means that we will never lose more than 5,000 euros in a day with a 95% confidence margin. The 1 day/95% VaR of a share of a certain company is 0.5 euros. This means there is a 95% chance that we would not lose more than 0.5 euros with each share of that company in the next 24 hours.
What's the purpose of VaR? Utilities
Value at risk or VaR is mainly used as a guide when making decisions about investments to ascertain the risk and return ratio. The higher this ratio, the riskier the investment or portfolio.
It's also useful as when it comes to diversifying. Depending on the percentage obtained when calculating the VaR, the composition of a portfolio can be modified to fit the desired risk profile.