Evaluating Value at Risk Methodologies: Accuracy Versus Computational Time

WFIC 96-48

Posted: 14 Jan 1997

See all articles by Matt Pritsker

Matt Pritsker

Federal Reserve Bank of Boston

Date Written: November 1996

Abstract

Recent research has shown that different methods of computing Value at Risk (VAR) generate widely varying results, suggesting the choice of VAR methods is very important. This paper examines six VAR methods, and compares their computational time requirements and their accuracy when the sole source of inaccuracy is errors in approximating nonlinearity. Simulations using portfolios of foreign exchange options show showed fairly wide variation in accuracy and unsurprisingly wide variation in computational time. When the computational time and the accuracy of the methods were examined together, four methods were superior to the others. The paper also presents a new method for using order statistics to create confidence intervals for the errors and errors as a percent of true value at risk for each VAR method. This makes it possible to easily interpret the implications of VAR errors for the size of shortfalls or surpluses in a firm's risk based capital.

JEL Classification: G20, G21, G24, G28

Suggested Citation

Pritsker, Matthew G., Evaluating Value at Risk Methodologies: Accuracy Versus Computational Time (November 1996). WFIC 96-48, Available at SSRN: https://ssrn.com/abstract=8032

Matthew G. Pritsker (Contact Author)

Federal Reserve Bank of Boston ( email )

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