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Describe the principal methods used by investment banks to compute their Value at Risk to movements in market prices. What are the advantages and limitations of using such measures?
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Describe the principal methods used by investment banks to compute their Value at Risk to movements in market prices. What are the advantages and limitations of using such measures? 1. Introduction Philippe Jorion defines Value at Risk (VaR) as a model used to "summarise the maximum loss on a portfolio in a given time horizon, within a given confidence level". VaR is the main method for financial institutions to measure their exposure to risk. In the world of banking today, risk management is becoming an important subject as banks strive to prevent events such as LTCM occurring again. There are several types of risks that banks face. These are: operational, market, credit, liquidity and business risks. There four steps to calculating VaR. First, the risk manager must collect all the data, regarding losses previously made and information about the risk factors involved. The risk factors must be identified. There are four main...
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