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Value at Risk (VaR)
is defined with respect to a specific portfolio of financial assets, at a specified probability and a specified time horizon. The probability that the mark-to-market loss on the portfolio over the time horizon is greater than VaR, assuming normal markets and no trading, is the specified probability level..
For example, if a portfolio of stocks has a one-day 5% VaR of $1 million, there is a 5% probability that the portfolio will decline in value by more than $1 million over the next day, assuming markets are normal and there is no trading. Such an event is termed a “VaR break.”
VaR has five main uses in finance: risk management, risk measurement, financial control, financial reporting and computing regulatory capital. VaR is sometimes used in non-financial applications as well.
Important related ideas are economic capital, backtesting, stress testing and expected shortfall.
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