MANAGING MARKET RISK WITH VaR (VALUE AT RISK)

Abstract

Market risk estimates the uncertainty of future earnings, due to the changes in market conditions. Value at Risk has become the standard measure that financial analysts use to quantify market risk. For estimating risk, the issue is that different ways to estimate volatility can lead to very different VaR calculations. The performance of SMA with rolling windows of 100 and EWMA using 0.94 (proposed by RiskMetrics) as smoothing constant λ and rolling window of 100 days, perhaps the most widely used methodology for measuring market risk is analyzed from investment activities on 7 stock exchange indices from developed and emerging markets. Binary Loss Function (BLF) is employed to measure the accuracy of VaR calculations because VaR models are useful only if they predict future risks accurately. The subject of this research is to determine the possibility of application of the SMA and EWMA models VaR with 95% and 99% confidence level in investment processes on the stock exchange markets of the selected countries. The methodology applied in the research includes analyses, synthesis and statistical/mathematical methods. The aim of the research is to show whether the models work the same and whether financial analysts from emerging countries can use the same model as their counterparts from the developed countries. The results show that risk managers in developing just as those in developed countries can use risk metric EWMA model as a tool for estimating market risk at 95% confidence level.