This one is (a little) tricky. Try out folks: On December 31, 2006, Portfolio A had a market value of $2,520,000. The expected return on the portfolio for the upcoming year was 12%, and its historical standard deviation of daily returns was 1.7%. Assuming that Portfolio A is normally distributed, calculate the daily VAR(2.5%) on a dollar basis and state its interpretation. Daily VAR(2.5%) is equal to: A) $83,966, implying that daily portfolio losses will fall short of this amount 2.5% of the time. B) $70,686, implying that daily portfolio losses will only exceed this amount 2.5% of the time. C) $70,686, implying that daily portfolio losses will fall short of this amount 2.5% of the time. D) $83,966, implying that daily portfolio losses will only exceed this amount 2.5% of the time.
my answer is d. Pls let me know whether it’s correct.
The answer is correct. Okay so the mistake I made was that I used expected returns of 1.7%. The formula that I had used was VAR = N*(ER - z*std.dev.) = 2520000*(.012 - 1.96*.017) Why is it that we have ignored the Expected returns here? Can you please clarify this… thanks in advance.
The expected return of 12% here is for the year which gives a daily return of (I dunno) 5 bp. That means the expected return is small compared to the std. dev. and can safely be ignored. On a philosophical note, I don’t ever use “expected returns” in VaR calculations because I am interested in knowing about risk independently of how much money someone thinks they are going to make.
Makes perfect sense… Thanks a ton! 