In Calc. of VaR, the Mean P/L is just loss?

[Steve Jobs]

When it's mentioned in the question that the Mean P/L is 10%, then what the question actually is saying is that the mean loss is 10%? and is that why it's included as negative amount in the equation?

 

[ShaktiRathore]

Hi when we include mean P/l its the net gain or loss the portfolio has earns while calculating the absolute Var we take it as negative so as to reduce the overall Var that is the largest loss that can occur over a given time frame at a certain confidence level. So if the portfolio expected mean gain is +10% than we subtract it from the Var so as the maximum loss that portfolio can suffer is Var- gain on portfolio and thus calculate overall worse loss possible for the portfolio whereas if there is loss expected than we add this to the Var calculated to get an overall absolute Var. This we consider the mean gain as negative because it reduces the Var and mean loss as positive because it increases the Var thus we include gain/loss as negative.
Var is itself a loss so that we subtract gain and add the loss possible on the portfolio. If we expect to loss 100$ by next day and expect 10% return on it than by next day my overall loss expected is 100-10=90 so this is my worst loss possible put in formula Var=-mean+z*sigma*P
Var=-10+100=90
And if there is a loss of 10% expected than we overall loss =100+10=110 VaR=-(-10)+100=10+100=110$
hope u understood
thanks

 

[Steve Jobs]

Hi Shakti,

Sorry for the late reply.

Yeah, now I understand the mechanism for when to add and when to deduct. Ate same time, now, it raises more questions about the concept of VaR itself which I will ask when I review the questions again.

Thanks again Shakti,

 

[Steve Jobs]

Hi,
I reviewed few practice questions and I can see the logic mentioned by you, Shakti.

In another matter, in the practice questions, it seems that they differentiate between VaR (Normal Distribution) and VaR (Arithmetic Returns).
However, I don't really understand the concept but I don't see any difference in solving the questions as in both, the answer is -gain + SD*z. (Even in Longnormal, it's almost the same formula with little differences)

Am I missing something?

 

[ShaktiRathore]

Hi to clarify your doubts please go through these links:
http://forum.bionicturtle.com/threads/lognormal-distribution.7115/#post-25872
http://forum.bionicturtle.com/threads/relative-vs-absolue-var.7246/#post-25826
http://forum.bionicturtle.com/threads/can-anyone-help-me-on-this-questions.6911/#post-23788
thanks

 

[Steve Jobs]

Thanks Shakti, I'll go through them.

 

[Steve Jobs]

I was reading a practice question and noted the below according to this question:

a. under IRB, at 99.9 confidence level, 1 year time horizon, the estimated VaR is 100m
b. the expected loss is 40m
c. how much is the value of economic value?

Answer provided: expected loss is covered by provisions. economic capital is for unexpected loss. the answer is 100-40=60

I just wanted to be assured that there is no inconsistency between this question and the logic explained in above in reply no. 2.
In above reply, the mean loss was added to VaR but in this question, the expected loss is deducted from VaR. Please advise.