Strategic Risk Taking: A Framework for Risk Management by Aswath Damodaran
Author:Aswath Damodaran
Language: eng
Format: mobi
Publisher: Pearson Education
Published: 2007-08-01T14:00:00+00:00
Because the product of all three approaches is the VaR, it is worth asking two questions.
• How different are the estimates of VaR that emerge from the three approaches?
• If they are different, which approach yields the most reliable estimate of VaR?
To answer the first question, we have to recognize that the answers we obtain with all three approaches are a function of the inputs. For instance, the historical simulation and variance-covariance methods will yield the same VaR if the historical returns data is normally distributed and is used to estimate the variance-covariance matrix. Similarly, the variance-covariance approach and Monte Carlo simulations will yield roughly the same values if all the inputs in the latter are assumed to be normally distributed with consistent means and variances. As the assumptions diverge, so will the answers. Finally, the historical and Monte Carlo simulation approaches will converge if the distributions we use in the latter are entirely based on historical data.
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