“we limit fund losses to 2% of assets with a 99% level of confidence”
Solution:
VaR is an expression of a minimum loss. It is incorrect for Patterson to state that the policy will limit fund losses to 2%over a 5- day period.
Why this?
VaR is a minimum loss if stated as a 1% (or 5%) VaR. But given a 99% level of CONFIDENCE means that we are 99% sure that losses would not exceed 2% of assets. Other way around in 1% of the cases the minimum loss would be 2%.
They are not giving the % VaR in this case, but the level of confidence!
No, VaR is the minimum loss if it’s stated like: 1%VaR is 20%. That means that the minimum loss is 20%. But if it’s stated (like in the question above) that the 99% confidence level of the VaR is 20% means that 99% of the time the loss is not more than 20%!
If I have let say 5% of probability of having a loss of minimum 10% then I have 95% of the time I have a loss of less than 10%
“We limit fund losses to 2% of assets with a 99% level of confidence, with additional measures to limit total losses to 3% over a rolling 30-day period”
you never know the shape of the tail, in fact it’s a problem of VaR (there are several quant methods to modify the var calculation with fatter tails,…)
I am quite sure what I am saying in this discussion… CFA is doing something wrong here
A 1% VaR (99% confidence) is the point on the distribution 2.33 standard deviations below the expected value
-> this is equivalent to 2% of assets
Below is from curriculum note 2.
Using the example given, it is correct to say
• 2% assets is the minimum loss we would expect 1% of the time; or
• 1% of the time, losses would be at least 2% of assets; or
• we would expect a loss of no more than 2% of assets 99% of the time.
The last sentence is sometimes mistakenly phrased as “99% of the time we would expect to lose less than 2% assets,” but this statement could be taken to mean that 99% of the time we would incur losses, although those losses would be less than 2% assets. In fact, a large percentage of the time we will make money.
sorry but you are saying exactly what I was saying since from the beginning.
“we would expect a loss of no more than 2% of assets 99% of the time.” is exactly what I mean which is different from what CFA is saying in the mock’s solution.
“we limit fund losses to 2% of assets with a 99% level of confidence” is not the same as “we would expect a loss of no more than 2% of assets 99% of the time.”
I know, the whole discussion here is exactly about this point
“we limit fund losses to 2% of assets with a 99% level of confidence” is not the same as “we would expect a loss of no more than 2% of assets 99% of the time.”
This means that with a confidence of 99% we are not going to have losses bigger than 2%.