Measures of risk: VaR and Stress Flashcards
What does VaR stand for?
Value at Risk
What is VaR? Give an example.
Probability during a given time period that a portfolio will lose $X
Eg, 1% one-year VaR of $10M means there’s a 1% chance a portfolio will lose $10M in one year
What is a stress test?
A test to measure risks to firms or portfolios. It tries to measure how well a portfolio or firm will stand up under the stress of a financial crisis
What are 3 basic questions a stress test might ask?
- what if there were a severe recession?
- what if the dollar appreciated or depreciated?
- what if there were a short term liquidity crisis where ability to borrow in the short term dries up?
What is the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010?
In response to the 2007-2008 financial crisis, this act mandated that the Federal Reserve perform stress testing (not which tests, but that there should be at least three) of non-bank financial institutions that it supervises
What is the difference between VaR and variance?
Portfolio variability measure is called variance. VaR is value at risk and measures probability of gain/loss in $ for a given time horizon
How does the federal reserve conduct stress testing?
collects information from the firm about its interconnectedness w/ other institutions, eg, everything it owns, how safe it is, and then ask what if severe recession, what if short term liquidity crisis, what if dollar depreciated/appreciated?
