Maxvar - Long Horizon Value at Risk in a Mark-to-Market Environment
Journal of Investment Management, Vol. 2, No. 3, Third Quarter 2004
Posted: 16 Sep 2004
The standard VaR approach considers only terminal risk, completely ignoring the path of the portfolio value prior to this final horizon. This assumption is unrealistic-interim risk may be critical in a mark-to-market environment because interim values of a portfolio may generate margin calls and affect trading strategies. We provide a simple framework for adjusting standard VaR for interim risk. We introduce the notion of MaxVaR, which is analogous to VaR except that it considers the probability of seeing a given low cumulative return on or before the terminal date. Under the standard lognormality assumption and for reasonable parameterizations, MaxVaR may exceed VaR by over 40%. We show that adjusting VaR for interim mark-to-market risk is critically important for high Sharpe Ratio portfolios (e.g., for hedge funds).
JEL Classification: G00
Suggested Citation: Suggested Citation