Value at Risk and Correlation

The curriculum explains the difference between VAR and Scenario Analysis and one of the statements affirms that VAR is vulnerable to the difference between past and future correlations and that it largely focuses on recent historical correlations and volatilty. However, isnt VAR just looking at the probability of losing a certain amount of money in your portfolio? Where is the correlation in this case?

You’ve kind of answered your own question; how do you suppose those probabilities are calculated?

To calculate the possible losses, you need to know how much you can lose in each investment, and how those individual losses will combine into the overall portfolio loss. The correlations of prices figure into that combination.

I don’t think i understood why correlation is a limitation for VAR .

When we say that the liquidation is a limitation of VAR, is it because VAR just tells you the minimum losses, but not the maximum?

Future correlations of prices or returns may differ from past correlations. Furthermore, correlations tend to move toward +1.0 in times of financial crisis.

Do you mean liquidation, or liquidity?

One limitation of VaR is that it doesn’t consider the liquidity of the portfolio assets.

@s2000 magician, thank you for your explanations :slight_smile: and yes i meant liquidity