I'm struggling to understand part 2 of this question - value of VaR and TailVaR.
From my understanding for Company AA,
VaR(X) = -t where t=max{x: P(X<x)<=p)
In this case, p=0.05
X (return as %) Prob
6% 0.9811
-100% 0.0189
So here, P(X<6) is not less than 0.05
therefore t = -100%
so VaR(X) = 100%, which I think means that we are 95% certain that the expected loss will be £100. but this doesn't match the answer, but I can't get my head around where I am going wrong. I guess my interpretation isn't quite right.
In the revision book, it uses the risk neutral probabilities:
X (% return) probability
6% 0.9811
-100% 0.0189.
The solution then goes on to state that VaR(X) = -6%. But again, this doesn't make sense since the probability associated with a 6% return is 0.9811, hence greater than 0.05, meaning the condition P(X<x)<= 0.05 is not met.
Also struggling to understand why the VaR(X) for a 50:50 investment in Company AA and BB is 46%
Help please!
Last edited by a moderator: Feb 27, 2021