To VaR, or Not to VaR, That is the Question

Olkhov, Victor (2021): To VaR, or Not to VaR, That is the Question.

Abstract

We consider economic obstacles that limit the reliability and accuracy of value-at-risk (VaR). Investors who manage large market transactions should take into account the impact of the randomness of large trade volumes on predictions of price probability and VaR assessments. We introduce market-based probabilities of price and return that depend on the randomness of market trade values and volumes. Contrary to them, the conventional frequency-based price probability describes the case of constant trade volumes. We derive the dependence of market-based price volatility on the volatilities and correlation of trade values and volumes. In the coming years, that will limit the accuracy of price probability predictions to Gaussian approximations, and even the forecasts of market-based price volatility will be inaccurate and highly uncertain.

• Item Type: MPRA Paper
• Language: English
• Keywords: value-at-risk; price probability; market trade
• Subjects: C - Mathematical and Quantitative Methods > C0 - General > C02 - Mathematical Methods; D - Microeconomics > D4 - Market Structure, Pricing, and Design > D46 - Value Theory; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; G - Financial Economics > G1 - General Financial Markets; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation

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