Chapter 9 Credit risk

In this way, the maximum potential loss is computed. The expected loss (normally treated as a cost of doing business) is deducted in order to compute the value at risk.

I think this means that VaR is targeting unexpected losses. Banks accept a level of expected defaults as part of their business, and these should be stripped out of any VaR figure for a bank. It probably doesnt affect insurance companies etc, that dont build in expected levels of default into their business models.

Also this sentence with respect to liquidity risk
Specifically, an increase in the implied volatility of assets will drive
up the marginal cost of funds through an increase in the liquidity premium (the margin required to reflect the fact that the risk of loss over a long time period is greater than it is over a short time period).


This sentence from Chapter 10 pg 22 refers to the fact that when markets get nervous and volatile, the liquidity risk premium rises, pushing up the cost of funds for institutions (particularly banks). This is worse if the bank is trying to fund itself on a longer term basis. If the cost of funds rises, the profits will fall.