EVALUATING VALUE AT RISK METHODOLOGIES - ACCURACY VERSUS COMPUTATIONAL TIME

Recent research has shown that different methods of computing Value at Risk (VAR) generate widely varying results, suggesting the choice of VAR method is very important. This article examines six VAR methods, a nd compares their computational time requirements and their accuracy w hen the sole source of inaccuracy is errors in approximating nonlinear ity. Simulations using portfolios of foreign exchange options showed f airly wide variation in accuracy and unsurprisingly wide variation in computational time. When the computational time and accuracy of the me thods were examined together, four methods were superior to the others . The article also presents a new method for using order statistics to create confidence intervals for the errors and errors as a percent of true value at risk for each VAR method. This makes it possible to eas ily interpret the implications of VAR errors for the size of shortfall s or surpluses in a firm's risk-based capital.