Stressed Value-at-Risk

Stressed Value at Risk (Stressed VAR) in its advanced framework provides a realistic measure of market risk tailored for stressed market environments. The simpler regulatory version of Stressed VAR is a special case. Stressed VAR corrects various deficits of ordinary VAR in times of market stress. Stressed VAR incorporates scenario analysis in a VAR setting in a sophisticated and consistent fashion. The mathematical framework is familiar and simple, designed to be understandable in a practical way by risk managers, traders, and regulators. Specifically, the familiar Gaussian (normal) probability formalism is employed, but in a completely different way than for ordinary VAR, designed to account for tail risk and collective behavior. The two main ingredients for Stressed VAR are "fat-tail volatilities" that account for outlier events in the risk factors, and stressed correlations between risk factors that account for collective market participant behavior in stressed markets. This information is provided as input to standard Monte Carlo simulation to determine stressed market risks for a given portfolio. The VAR with the inputs of the fat-tail volatilities and the stressed correlations is the Stressed VAR. Bloomberg LP is implementing Stressed VAR in the PORT portfolio system.