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CA Final · Advanced Financial Management · Risk Management

Which of the following is a recognised limitation of Value at Risk as a risk measure?

A key limitation of VaR is that it does not indicate how large losses could be beyond the threshold. It only gives the cutoff loss at a chosen confidence level, so extreme tail losses are not described, which is why measures such as expected shortfall are used as supplements.

  1. AIt cannot be computed for portfolios with more than one asset
  2. BIt requires returns to be perfectly negatively correlated
  3. CIt gives no information on the size of loss beyond the VaR thresholdCorrect
  4. DIt always overstates risk when confidence level is above 95%

Explanation

VaR states a loss level that will not be exceeded at a given confidence, but says nothing about how severe losses can be in the tail beyond it. It can be computed for multi-asset portfolios and does not need negative correlation, and it does not systematically overstate risk at high confidence levels.

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