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Let’s re-phrase the statistic into both percentage and dollar terms: With 95% confidence, we expect that our worst daily loss will not exceed 4%. If we invest $100, we are 95% confident that our worst daily loss will not exceed $4 ($100 x -4%). You can see that VAR indeed allows for an outcome that is worse than a return of -4%. It does not express absolute certainty but instead makes a probabilistic estimate. If we want to increase our confidence, we need only to “move to the left” on the same histogram, to where the first two red bars, at -8% and -7% represent the worst 1% of daily returns: With 99% confidence, we expect that the worst daily loss will not exceed 7%. Or, if we invest $100, we are 99% confident that our worst daily loss will not exceed $7. This method assumes that stock returns are normally distributed. In other words, it requires that we estimate only two factors’an expected (or average) return and a standard deviation’which allow us to plot a normal distribution curve, letrozole 2 5 mg prix tunisie. Here we plot the normal curve against the same actual return data: The idea behind the variance-covariance is similar to the ideas behind the historical method’except that we use the familiar curve instead of actual data. The advantage of the normal curve is that we automatically know where the worst 5% and 1% lie on the curve. They are a function of our desired confidence and the standard deviation. Confidence # of Standard Deviations (?) 95% (high) – 1. The blue curve above is based on the actual daily standard deviation of the QQQ, which is 2. The average daily return happened to be fairly close to zero, so we will assume an average return of zero for illustrative purposes. Here are the results of plugging the actual standard deviation into the formulas above: Confidence # of ? Calculation Equals 95% (high) – 1. The third method involves developing a model for future stock price returns and running multiple hypothetical trials through the model. A Monte Carlo simulation refers to any method that randomly generates trials, but by itself does not tell us anything about the underlying methodology. For most users, a Monte Carlo simulation amounts to a “black box” generator of random, probabilistic outcomes. Without going into further details, we ran a Monte Carlo simulation on the QQQ based on its historical trading pattern. In our simulation, 100 trials were conducted. If we ran it again, we would get a different result’although it is highly likely that the differences would be narrow. To summarize, we ran 100 hypothetical trials of monthly returns for the QQQ. Among them, two outcomes were between -15% and -20%; and three were between -20% and 25%. That means the worst five outcomes (that is, the worst 5%) were less than -15%. The Monte Carlo simulation, therefore, leads to the following VAR-type conclusion: with 95% confidence, we do not expect to lose more than 15% during any given month.
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