What Is Backtesting in Value at Risk (VaR)?

The value at risk is a statistical risk management technique that monitors and quantifies the risk level associated with an investment portfolio. The 澳洲幸运5官方开奖结果体彩网:value at risk measures the maximum amount of loss𝔍 over a specified time horizon with a given confidence level.

澳洲幸运5官方开奖结果体彩网:Backtesting measures the accuracy of the value at risk calculations. It's the process of determining how well a strategy will perform using historical data.

The loss 🌳forecast calculate♊d by the value at risk is compared with actual losses at the time of the specified deadline.

Un🌠derstanding Backtesting in Value at Risk (VaR)

Backtesting can be helpful because it uses modeling of past data to 澳洲幸运5官方开奖结果体彩网:gauge an inves😼tment strategy's accuracy and effectiveness.

Backtesting in value at risk is used to compare the predicted losses from the calculated value at risk with the actua꧑l losses reali🐓zed at the end of the specified time horizon. This comparison identifies the periods where the value at risk is underestimated or the portfolio losses are greater than the original expected value at risk.

Potential Maximum Loss

Value at risk calculates the potential maximum losses over a specific time horizon with a degree of confidence. The one-year value at risk of an investment portfolio is $10 million with a confidence level of 95%. The value at risk indicates that there is a 5% chance of having losses that exceed $10 million at the end of the year. The worst expected portfolio loss over one trading year with 95% confidence won't exceed $10 million.

The calculated value at risk is an appropriate measure if the value at risk is simulated over the past year's data and the actual portfolio losses haven't exceeded the expected value at risk losses. The expected value at risk calculation may not be accurate, however, if the actual portfolio losses exceed t𝄹he calculated value at risk losses.

It's known as a breach of value at risk when the actual portfolio losses are greater than the calculated value at risk estimated loss. It doesn't mean that the estimated value at risk has failed, however, if the actual portfolio loss is above the estimated value at risk only a few times. The frequency of breaches must be determined.

Example of Backtesting in Value at Risk

The daily value at risk of an investment portfolio is $500,000 with a 95% confide🤡nce level for 250 days. The actual losses are expected to breach $500,000 approximately 13 days out of 250 days at the 95% confidence level.

There's only a problem with the value at risk estimates when breaches occur more than 13 days out of 250 days because this would signal that the value at risk estimate is inaccurate and should be re-evaluated.

The Bottom Line

An investment portfolio can be a delicate thing and investors are wise to monitor and manage their risks on an ongoing basis. The value at risk (VaR) is a statistical technique that can help quantify the risk level of a portfolio. It anticipates maximum loss🍌 across a specified horizon. Backtesting can measure the accurac꧋y of VaR projections.

Consider consulting with an advisor to ensure that you’re correctly interpreting the rꦗesults.