The Analytical (Variance-Covariance) Method for Estimating Value at Risk (VaR)
One way to estimate VaR is the analytical method, also called the variance-covariance method.
This method assumes a normal distribution of portfolio returns, which requires estimating the expected return and standard deviation of returns for each asset. As the number of securities in a portfolio increases, these calculations can become unwieldy. As a result, a simplifying assumption of zero expected return is sometimes made. This assumption has little effect on the outcome for short-term (daily) VaR calculations but is inappropriate for longer-term measures of VaR.
The advantage of this method is its simplicity. The disadvantage is that the assumption of a normal return distribution can be unrealistic.
For more information, see all articles on: Governance, 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)
