Alternative measures to value at risk

Colin J. Thompson and Michael A. McCarthy

Journal of Risk Finance, 2008, vol. 9, issue 1, 81-88

Abstract: Purpose - The purpose of this article is to introduce a new method of estimating risk as an alternative to value at risk (VaR), drawing on the risk assessment literature in environmental science. Design/methodology/approach - A commonly used and accepted measure of market risk is VaR, defined as the difference between initial portfolio value and a probabilistic lower boundBon the portfolio value at timeT. To take account of situations where the portfolio value may fall belowBprior to timeT, an an alternative to VaR is proposed based on first passage time distributions. Findings - It is argued that the resulting expected minimum portfolio value over the time frameTprovides a clear alternative measure of market risk. Analytical expressions are obtained and numerical comparisons given when the distribution of portfolio returns is lognormal. Research limitations/implications - Analytical results are presented for lognormal distributions for returns. Results for other models can be easily obtained from simulation. Practical implications - The new measure of risk recognizes that investors might be sensitive to risks of decline in the value of a portfolio at any time within a given time horizon, not just at the end of the anticipated period of investment. The expected minimum portfolio value measures the largest loss that is expected at some stage over that period. Originality/value - A new measure of risk is presented that arises from literature on risk assessment in environmental science. It is complementary to VaR for assessing risk.

Keywords: Risk analysis; Risk management; Distribution functions; Portfolio investment (search for similar items in EconPapers)
Date: 2008
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jrfpps:15265940810842438

DOI: 10.1108/15265940810842438

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