Financial Risk Management – Concept, Practice and

Application
Parametric VaR calculation methods
Parametric VaR calculation methods
Index:
•Normal Distribution VaR calculation
•Lognormal Distribution VaR calculation
•Q & A
•Normal VaR vs Lognormal VaR
Normal distribution VaR

Normal distribution VaR Normal distribution

VaR Normal = (- µ r + σr x Zα) x V

Notations:
µ r = % return on asset or portfolio
σ r = % standard deviation of returns
Zα = Z-Value from Z chart
V = Value of Position or Portfolio
Lognormal distribution VaR

Lognormal distribution VaR Lognormal distribution

(µ r- σr x Zα)
VaR lognormal = (1- e )xV
Notations:
e = exponential value = ~ 2.718
µ r = % return on asset or portfolio
σ r = % standard deviation of returns
Zα = Z-Value from Z chart
V = Value of Position or Portfolio
Compare Normal vs Lognormal VaR formula

VaR Normal = (- µ r + σr x Zα) x V

(+ µ r- σr x Zα)
VaR lognormal = (1- e )xV
Calculate normal distribution VaR
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate normal VaR (Zα = 1.65):

A) 562,500
B) 262,500
C) (300,176)
D) 230,874
Calculate normal distribution VaR
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate normal VaR (Zα = 1.65):

A) 562,500
B) 262,500
C) (300,176)
D) 230,874
Calculate normal distribution VaR
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate normal VaR (Zα = 1.65):

A) 562,500 Solution: B
VaR Normal = (- µ r + σr x Zα) x V
B) 262,500 = (-15% + 25% x 1.65) x USD 1 Million
= (-15% + 41.25%) x USD 1 Million
C) (300,176) = USD 262,500

D) 230,874
Calculate lognormal distribution VaR
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate lognormal VaR (Zα = 1.65):

A) 562,500
B) 262,500
C) (300,176)
D) 230,874
Calculate lognormal distribution VaR
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate lognormal VaR (Zα = 1.65):

A) 562,500 Solution: D

B) 262,500 VaR lognormal = (1- e (µ r- σr x Zα)) x V

= (1 – e(15% -25% x 1.65))x USD 1 Million
C) (300,176) = (1 - 2.718(15% -25% x 1.65)) x USD 1 Million
D) 230,874 = (1- 0.76912636) x USD 1 Million
= USD 230852.7 ~ USD 230,874
VaR calculation on different time scale
Considering 252 working days in a year

10-Day lognormal VaR:

• Annual VaR % = - µ r + σr x Zα

• 10-Day VaR % = (- µ r x 10/252) + (σr x Zα x 10/ 252) (1- e )

(µ r x 10/ 252) – (σr x Zα x 10 / 252)

• Weekly VaR % = (- µ r x 5/252) + (σr x Zα x 5/ 252)

• 1-Day VaR % = (- µ r /252) + (σr x Zα x 1 / 252)

Calculate VaR (1-Day)
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate normal and lognormal VaR (Zα = 1.65) for 1-day
holding period (consider 252 days in a year):

A) 411,905; 337,613
B) 1,042; 1,041
C) 25,390; 25,070
D) 262,500; 230,874
Calculate VaR (1-Day)
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate normal and lognormal VaR (Zα = 1.65) for 1-day
holding period (consider 252 days in a year):

A) 411,905; 337,613
B) 1,042; 1,041
C) 25,390; 25,070
D) 262,500; 230,874
Calculate VaR (1-Day)
A risk analyst is estimating VaR of a position of USD 1 million. Considering annual
volatility and return of 25% and 15% respectively. After discussing with his CRO, he
concluded that the VaR at 5% probability (α) would fetch the appropriate VaR for
the given position. Calculate normal and lognormal VaR (Zα = 1.65) for 1-day
holding period (consider 252 days in a year):

A) 411,905; 337,613 Solution: C

B) 1,042; 1,041
C) 25,390; 25,070
D) 262,500; 230,874
1-Day Normal VaR = ( (- µ r /252) + (σr x Zα x 1 / 252) ) x V
=( (-15/252) + (25%/1.65 x 1 / 252)) x V
= 25,390
(µ r /252) – (σr x Zα / 252)
1-Day VaR lognormal = (1- e
252)
) xV
= (1- e (15%/252) – (25% x 1.65 / ) x USD 1 Million
= USD 250,70
Normal VaR vs Lognormal VaR
Normal VaR value will be more than lognormal VaR value
Return = 15% p.a
Sd = 25% p.a
Z value = 1.65 (5% probability)
V = USD 1 Million

Period Return Sd Normal VaR Lognormal VaR Difference

252 15.00% 25.00% 262,500 230,874 31,626
126 7.50% 17.68% 216,682 194,814 21,868
63 3.75% 12.50% 168,750 155,280 13,470
25 1.49% 7.87% 115,044 108,673 6,371
10 0.60% 4.98% 76,220 73,387 2,832
5 0.30% 3.52% 55,128 53,636 1,492
1 0.06% 1.57% 25,390 25,070 320
Normal VaR vs Lognormal VaR
Normal VaR value will be more than lognormal VaR value
Return = 5% p.a
Sd = 10% p.a
Z value = 2.33 (1% probability)
V = USD 1 Million

Period Return Sd Normal VaR Lognormal VaR Difference

252 5.00% 10.00% 183,000 167,232 15,768
126 2.50% 7.07% 139,756 130,430 9,326
63 1.25% 5.00% 104,000 98,775 5,225
25 0.50% 3.15% 68,428 66,139 2,289
10 0.20% 1.99% 44,431 43,458 973
5 0.10% 1.41% 31,828 31,327 501
1 0.02% 0.63% 14,479 14,375 104