Value at risk (VaR).

In plain English

Value at risk answers one question with three parts: over this time horizon, with this probability, losses should not exceed this amount. A one day 95 percent VaR of 50,000 means that on 19 days out of 20 the loss should stay under 50,000, and it says nothing about the size of the loss on the twentieth day. Banks and asset managers calculate it from historical returns, from an assumed distribution, or from simulation, and the three methods can give different answers on the same portfolio. Regulators require versions of it for bank capital. The measure's blind spot in the tail is a known and much criticized limitation.

01Why it matters

VaR is a floor on how bad things get, not a ceiling, so treating it as a worst case is exactly the misreading that has damaged institutions in past crises.

02The math, step by step

A 1 million portfolio has a one day 99 percent VaR of 25,000, which is 2.5 percent. That means about 1 trading day in 100, roughly two or three days a year, the loss should exceed 25,000. How far past 25,000 those days go is not part of the number.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT

04Receipts

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