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FRM Part I · FRM Exam Part I · Measures of Financial Risk

A risk manager reports that a portfolio's one-day 99% VaR is USD 5 million. Which interpretation is correct?

At 99% confidence, a USD 5 million one-day VaR means there is a 1% probability that the loss over one day exceeds USD 5 million. It is a loss quantile, not a maximum loss and not the average loss in the tail.

  1. AThe portfolio is expected to lose USD 5 million on average on the worst 1% of days
  2. BThere is a 1% probability that the one-day loss exceeds USD 5 millionCorrect
  3. CThe maximum possible one-day loss is USD 5 million
  4. DThe portfolio will lose at least USD 5 million on exactly one day in every 100

Explanation

VaR is a quantile of the loss distribution: losses are expected to exceed it with probability 1 − confidence level. The average loss beyond VaR is expected shortfall, not VaR. VaR is not a maximum loss and gives no guarantee of exact exceedance counts.

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