Value at Risk or VaR is a statistical measure of downside risk. Value at Risk measures the largest percentage of the portfolio value that you might lose over a given time period, to a given degree of certainty, based on historical average return and variability. For example, for a given asset held over the next six months, you might be 95% sure that the asset value will fall by no more than 15 percent.

Value at Risk (VaR) measures, with a specified probability, the expected worse dollar loss that might arise over a given time horizon.

Value at Risk has become widely used since the 1994 introduction of J. P. Morgan's RiskMetrics^® system, which provides the data required to compute Value at Risk for a variety of financial instruments. More information is directly available via internet from RiskMetrics. New Federal Reserve Board rules require banks to compute the Value at Risk of all their assets, and this total firm-wide VaR determines the bank's capital requirements.

The BIRR^® Performance Analyzer allows you to compute the Value at Risk of any equity portfolio, or, more generally, of any asset for which you have a total return series. In particular, you can compute the Value at Risk of any manager or mutual fund for which you have total returns data.

To illustrate the concept of Value at Risk with a specific example, suppose you are interested in the VaR of the S&P 500. Your time horizon is one quarter, and you want to compute a VaR number that 95% of the time will correctly give your maximum loss over the next three months. For illustrative purposes, we use data ending in May 1996 to estimate the mean and standard deviation of the S&P 500 total return series. Using these estimates of the mean and standard deviation, Value at Risk is $5.34 per $100 of initial investment. That is, 95% of the time your worst three-month loss will be $5.34.