Budgeting of VaR Limits to Businesses or Trading Desks
3 Pages Posted: 3 Sep 2010 Last revised: 26 Aug 2015
Date Written: September 1, 2010
VaR and limits on VaR of individual portfolio or businesses. Investment banks and trading operations allocate VaR limits to various business units as means of allocating capital. This is also part of the regulatory framework with each business and the bank in total having VaR limits that is monitored.
In this paper, we discuss a method for budgeting the aggregate risk limit expressed in VaR terms to the various businesses. This will result in a set of VaR limits for the individual businesses. A primary input to the VaR allocation methodology is future revenues. Historical Sharpe Ratio measured as the ratio of expected revenues to volatility of revenue is used to back out VaR limits out of forward looking revenue targets. The approach is flexible and allows for overlaying the results to incorporate qualitative considerations such as differences between liquidity of desks or businesses. Finally, correlation between the business units is not incorporated.
Keywords: VaR Limits, VaR, Risk Budgeting
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