VAR for kids.

Can someone please explain this in terms a kid would understand? I get it (generally) but I feel I’m at risk for screw ups. I know this will be on the exam.

Lets say you have a bunch of halloween candy but a really mean big brother VAR is a measure of how much candy your brother can steal from you every time he walks by. If you measure this over a year, he steals a lot more candy then if you measure it over a day.

VAR is the minimum expected loss that a portfolio can lose, usually quoted at a 90% (5%, because we only care about the left tail) confidence interval. For example, a “5% VAR of $500” means there is a 5% chance that your portfolio will lose at least $500 over some period of time. VAR depends on the expected return and standard deviation. These are the inputs that determine what VAR is. You can 1) calculate it (VAR = expected return (1.65)(standard deviation)*Value of portfolio) 2) you can just look at the daily returns and standard deviations, rank them, and then pick the 5th worst return (if you look at 100 daily returns, or 10th worst for 200, etc.) 3) use Monte Carlo to give you a huge amount of return/sd combinations that will arrive at a VAR for you note that saying “5% chance a portfolio will lose at least $500” is the same thing as saying there is a “95% chance you won’t lose more than $500” knowing the above probably won’t be enough to get you points. you will most likely need to get into the advantages/disadvantages of it, how to manipulate it, etc. schweser pg. 178-183 lays it out pretty good. shouldn’t take more than 20 minutes to learn.

Thanks guys/gals.