Value at Risk
Derivative investment course work
Topic: Discuss and investigate VaR and its characteristics when applied to options. You must produce example calculations on:
European and American style options
Long and short positions in these
Portfolio of at least three different options (more is better)
Introduction
All financial institutions bear some sort of risk while dealing with different financial instruments, whether it be corporate treasurers, fund managers or financial institutions, they are all exposed to a certain market risks while carrying out their daily trading activities. There is a possibility that the institution makes a blunder in forecasting the future value of its trade and this may lead to major losses that have to be incurred by the institution. The exact number of this loss that the institution might bear is unknown and this had bothered many regulators with the fear of major banks going bankrupt, so mitigate the risk of bankruptcy the Basle committee on banking supervision, in April 1995, announced that capital adequacy requirements for commercial banks would be based on VaR. Later in the same year there was proposal issued by the security and exchange commission that required publicly traded U.S corporations to disclose information about derivative activity, with VaR measure as one of three possible methods for making such disclosures.(Jorion,P, 1996)
Value at Risk
Value at risk (VaR) is an attempt to provide a single number summarizing the total risk in the portfolio of financial assets. Var is the maximum loss that the institution will face on a given day. The basic variables involved in VaR measure is the time horizon and the confidence level e.g. an analyst calculating the VaR of a instrument(securities or derivatives) is a certain ‘X’ percent sure that his loss over the next ‘N’ days will not cross a certain value. In this ‘X’ percent would correspond to the confidence level that is assumed by the analyst, it could be any number from
Topic: Discuss and investigate VaR and its characteristics when applied to options. You must produce example calculations on:
European and American style options
Long and short positions in these
Portfolio of at least three different options (more is better)
Introduction
All financial institutions bear some sort of risk while dealing with different financial instruments, whether it be corporate treasurers, fund managers or financial institutions, they are all exposed to a certain market risks while carrying out their daily trading activities. There is a possibility that the institution makes a blunder in forecasting the future value of its trade and this may lead to major losses that have to be incurred by the institution. The exact number of this loss that the institution might bear is unknown and this had bothered many regulators with the fear of major banks going bankrupt, so mitigate the risk of bankruptcy the Basle committee on banking supervision, in April 1995, announced that capital adequacy requirements for commercial banks would be based on VaR. Later in the same year there was proposal issued by the security and exchange commission that required publicly traded U.S corporations to disclose information about derivative activity, with VaR measure as one of three possible methods for making such disclosures.(Jorion,P, 1996)
Value at Risk
Value at risk (VaR) is an attempt to provide a single number summarizing the total risk in the portfolio of financial assets. Var is the maximum loss that the institution will face on a given day. The basic variables involved in VaR measure is the time horizon and the confidence level e.g. an analyst calculating the VaR of a instrument(securities or derivatives) is a certain ‘X’ percent sure that his loss over the next ‘N’ days will not cross a certain value. In this ‘X’ percent would correspond to the confidence level that is assumed by the analyst, it could be any number from
References: Jorion,P (1996) “Measuring The Risk In Value At Risk” financial analyst journal Hoadley,P (2011) “Option Pricing Models and the "Greeks” Hull,j,c. (2010) “options, futures and derivatives” An excellent exposition of the Monte Carlo method is given by Hammersley and Handscomb (1964). Shreider (1966). Fishman (1973) and Meyer (1956) provide additional useful references.