For reading # 17, question # 23, it tells you that an increase in expected return will lower the overall VAR. While the theory behind this makes total sense, I’m confused about the equation as it seems to contradict this.
VAR = (expected return - probability level x standard deviation) x value of portfolio
Based on that equation, if expected return goes up, so does VAR. Am I missing something?
remember that VAR is something negative that is happening.
If E® = 7%, StdDev = 5% -> VAR = 7 - 1.65(5) = -1.25%
Say a 100Mill Portfolio => VAR = -1.25 Mill.
If E® becomes 8% VAR = -0.25%
so VAR gets lowered to 0.25 Mill for the same 100 Mill portfolio.
Yes.
Everytime I’ve seen it, E® is < (std. deviation * probabillity level)
For instance, we may have an E® of 8% vs. a std. deviation of 12% and a probability level of 2.33 (= 1%).
[0.08 - 2.33(0.12)] = -0.1996
If the E® goes up to 10% and the std. deviation and probability level remain the same, then the overall VaR will be lower than before.
[0.10 - 2.33(0.12)] = -0.1796
cpk- answering these questions is more fun than re-studying your notes, wouldn’t you agree?
p.s. we met at the Creighton Bootcamp in '12
I think -1.7 > -1.9
however you are looking at how much of a loss so it is comparing 1.7 vs. 1.9 and 1.7 is lower in terms of amount of loss. (you are not comparing -1.7 against -1.9 on the number line, if you know what I mean).
The VAR is always a negative value since usually 1.65 or 2.33 x st dev is greater than the E®.
The more theE® increases the less the VAR (probability of losses) since you are expecting to earn more so logically your losses would be lower… I hope this helps.
If u expect higher returns, you should also consider higher SD, that will keep VAR at similar levels and wont make equation +ve.
There would be some assets where equation would be +ve, ofcourse returns wont be higher.