The Historical Method for Estimating Value at Risk (VaR)
One way to estimate VaR is to use the historical method, which graphs the actual daily returns over a user-specified past period into a histogram. For a two-year observation period (500 trading days) the 1% VaR would be the loss on the fifth-worst day, and the 5% VaR would be the loss on the 25th-worst day.
The results reflect past results, not necessarily those that will be encountered in the future. It is also important to adjust for a moving investment horizon. For example, calculating the VaR for bonds expiring in 2020 from historical results of the prior year would be best done using bonds expiring in 2019.
An advantage of the historical method is that it is non-parametric, which means it does not require assumptions for probability distribution. The disadvantage is that the past may have very different risk characteristics from the future.
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)
