Hello, may someone please kindly explain how VAR is used to determine the total risk budget when doing the risk budgeting process. It's part of step 2 in the risk budgeting process and I'm finding it hard to understand how VAR is actually used in terms of determining the total risk budget. Thanks.
Hi Batsirai I suspect a wide range of approaches are possible here. But in essence, risk budgeting allows you to to take a holistic view of risk ie determine the overall level of risk you want to take, and then decide where to take it. VaR could be used as the measure of risk. Eg you might decide that the maximum level of risk you are prepared to take (your total risk budget) is such that there is a 95% chance that, over the next year, the value of your assets will fall by no more than £2m. You could then split this total risk budget between strategic risk and active risk and again use VaR to assess the riskiness of different investment strategies and investment managers to identify a strategy and set of managers that remains within your risk budget Hope that helps Gresham
