Methodology of Value at Risk (VaR)
VaR or Value at Risk measures maximum potential loss in value of an asset or portfolio over a defined period at a given confidence interval. VaR is used to estimate maximum downside risk of an investment.
Thus, if the VaR of an asset is Rs. 10 lakh for a week at 95% confidence level,
then it means Rs. 10 lakh is the maximum potential loss expected during any given
week in that asset at 95% confidence level. There is, however, a 5% chance that
the value of the asset will change by more than Rs. 10 lakh during a week.
Underlying formula used for computation of VaR::
Market Value of the Asset * Confidence Factor * Volatility of the Holding Period