Historic value at risk (historic VAR) is a risk management tool that estimates the potential loss in value of an investment over a defined period, based on historical data. It is expressed as a percentage and typically calculated at a specific confidence level, such as 95% or 99%. Historic VAR is computed by analysing the historical performance of the investment and determining the level of loss not exceeded for a given percentage of the time.
Historic VAR is used by investors and risk managers to gauge the potential for losses in their investment portfolios. It provides a quantifiable measure of downside risk based on past market behaviour. For example, a 95% historic VAR of 5% suggests that there is a 95% probability that the investment will not lose more than 5% of its value over the specified period.
While historic VAR is a useful tool for risk assessment, it has limitations. It relies solely on historical data and assumes that future market movements will mirror the past. This method may not account for unprecedented market events or structural changes in the markets. Investors should use historic VAR in conjunction with other risk measures and consider the broader economic and market context.
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