Using Value at Risk (VAR) to Allocate Capital
Firms or managers can assign a limit to the Value at Risk (VaR) as a proxy for capital allocations. For example, instead of assigning a limit of $100 million in capital to a given project, the firm may only allocate sufficient capital to have a 5% chance of losing more than $10 million in a given month (a $10 million monthly VaR at 5%). Riskier projects would receive less capital than less risky projects.
Allocating the capital in terms of units of exposure can bring projects into greater harmony with an overall risk management process, but the limits set are only as effective as the underlying VaR calculations. Moreover, the relationship between the individual project VaR and that of the overall firm can be complex and often counterintuitive.
For more information, see all articles on: Active Management, Asset Allocation, Investment Returns, Portfolio Management, Risk Management See also:
The Intelligent Investor: The Classic Text on Value Investing
Financial Statement Analysis: A Practitioner's Guide, 3rd Edition
Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series)
