What is the basic idea of Value at Risk (VaR)?

What is the basic idea of Value at Risk (VaR)?

• A. The maximum expected loss over a specified time horizon at a given confidence level.
• B. The minimum potential loss over a specified time horizon.
• C. The average cash inflow over the horizon.
• D. The worst possible loss over an infinite horizon.

Answer: (A)

VaR expresses a loss threshold tied to a probability for a given time horizon. It is the maximum loss that is not expected to be exceeded, at a specified confidence level, over that horizon. For example, a 1-day VaR at 95% means there is a 95% chance that the loss on the next day will be at or below that threshold; there is a 5% chance losses exceed it. This helps quantify downside risk and compare portfolios. It is not the minimum potential loss, nor the average cash inflow, nor the worst possible loss over an infinite horizon. The emphasis is on a probabilistic bound for the short horizon.

VaR expresses a loss threshold tied to a probability for a given time horizon. It is the maximum loss that is not expected to be exceeded, at a specified confidence level, over that horizon. For example, a 1-day VaR at 95% means there is a 95% chance that the loss on the next day will be at or below that threshold; there is a 5% chance losses exceed it. This helps quantify downside risk and compare portfolios. It is not the minimum potential loss, nor the average cash inflow, nor the worst possible loss over an infinite horizon. The emphasis is on a probabilistic bound for the short horizon.