Non-Linear Value-at-Risk

European Finance Review, Vol. 2, Iss. 2, May 1999

Posted: 21 Sep 1999

See all articles by Mark Britten-Jones

Mark Britten-Jones

London Business School - Institute of Finance and Accounting

Stephen M. Schaefer

London Business School - Institute of Finance and Accounting

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Abstract

Value-at-risk methods which employ a linear ("delta only") approximation to the relation between instrument values and the underlying risk factors are unlikely to be robust when applied to portfolios containing non-linear contracts such as options. The most widely used alternative to the delta-only approach involves revaluing each contract for a large number of simulated values of the underlying factors. In this paper we explore an alternative approach which uses a quadratic approximation to the relation between asset values and the risk factors. This method (i) is likely to be better adapted than the linear method to the problem of assessing risk in portfolios containing non-linear assets, (ii) is less computationally intensive than simulation using full-revaluation and (iii) in common with the delta-only method, operates at the level of portfolio characteristics (deltas and gammas) rather than individual instruments.

JEL Classification: G11, G12

Suggested Citation

Britten-Jones, Mark and Schaefer, Stephen M., Non-Linear Value-at-Risk. European Finance Review, Vol. 2, Iss. 2, May 1999. Available at SSRN: https://ssrn.com/abstract=167248

Mark Britten-Jones (Contact Author)

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

Stephen M. Schaefer

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 171 706 6887 (Phone)
+44 171 724 3317 (Fax)

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