A misplaced reliance on value at risk (VaR) has been focused on in the media as one of the main reasons for the current financial crisis, and the recently published Turner Review by the UK Financial Services Authority concurs. The purpose of this paper is to present an introductory overview of VaR and its weaknesses which will be easily understood by non‐technical readers.
Simple numerical examples utilising real and simulated data are employed to reinforce the main arguments.
This paper explains that some of the main approaches employed by banks for computing VaR have serious weaknesses. These weaknesses have contributed to the current financial crisis.
Consistent with the introductory nature of this paper, the empirical research is limited to simple examples.
The evidence here suggest that if VaR is to play a major role under future financial regulation then research is required to develop improved estimation techniques and backtesting procedures.
This paper differs from many academic papers on VaR by assuming only a very basic knowledge of mathematics and statistics.
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