I need some help with VaR for my work. I understand the concept of VaR, but what do portfolio managers, risk managers, and traders do when they experience a VaR “break”. Do they make adjustments to the portfolio or how do they handle these scenarios?
I think it’s up to the risk managers to decide what kind of environment that the portfolio hit it’s VaR amount. IE, if risk managers believe that it’s a very short period of high volatility then they may adjust the VaR levels for the time being. However, if they believe that the movement is not a short-term ‘fluke’ then they may want traders to rebalance the portfolio so that they are in range again.
I believe total VaR is spread around several desks. If true, I’m interested to know that, if in times of high volatility, if the VaR boundaries are compressed for one desk and widened for some other group or trader that wasn’t near the top end of the VaR range.
Maybe I am thinking about this wrong, but when I think of a VaR break, I am thinking of a return that falls outside the confidence level (ie 99%). It sounds like you are referring to the VaR limit as a dollar figure. For example, a 99% chance that losses will not exceed $1million over the next 3 days. So if losses get close to or exceed the $1 million VaR, you are saying that traders would rebalance but what do you mean by saying rebalance to be in range again? If their losses have already exceeded the $1 million VaR, what happens next?