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Is it correct to calculate the VaR as 99% max between loss and profit. E.g. if 99% VaR on the loss side of the distribution is -100, and on the positive side of the distribution there is a value corresponding to 120 at 99% confidence interval. Is it correct to say that the VaR is then 120?

My thinking is that VaR should be the value corresponding to the 99% worst loss , so if p&l vector has -100, 80, -90, 45, 120 ... until n=500. The worst 5th scenario from the negative numbers is the VaR when the numbers are arranged from smallest to the largest for all 500 observations, with the smallest number starting with a negative value and largest number being positive.

Also, please explain on the concept of Absolute VaR, as my understanding is that absolute VaR is just the VaR relative to 0, whereas relative VaR is the VaR relative to some expected return.

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Terminology around some risk measures can sometimes be very precarious. In your first paragraph, you have got things unnecessarily complicated. If you are looking at a sorted vector of 500 P&L, then your 99% VaR would simply be the P&L corresponding to the 4th smallest number in the vector (e.g. $500 \times (1-0.99) = 5$).

In the second paragraph, you pretty much got this.

Absolute VaR is sometimes referred to as conservative VaR or VaR without the mean. However, conservativeness of it is quite questionable, especially if the mean is negative value. Assuming that you did have a positive mean (historically) you will see a similar distribution to the the following:

Pic

On the left side (blue), you see de-meaned P&L (in percentage terms). And if you calculated your VaR from this distribution, you would get a smaller or more conservative number than the VaR from the distribution on the right side (red).

Also, your future expected return may or may not be equal to the mean return that you calculated using some historical data. Therefore, you would de-mean the series first and add back your expected mean to the P&L, if you wanted to see more realistic or as you wrote above, Relative VaR.

Keep in mind that a coherent risk measure should satisfy the monotonicity criteria, which VaR actually does. What this criteria states is that if you have the same P&L distribution, but the means (or expected returns) are different, the you would have less risk for the distribution with higher mean.

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  • $\begingroup$ Am i correct to then say that the VaR corresponds to the 99% one-sided confidence interval? Would it be rational to take the absolute value of the P&L distribution and get the 99% confidence interval from the absolute values of the 500 scenarios? $\endgroup$ – One Pablo Nov 25 '19 at 13:16
  • $\begingroup$ Yes, VaR looks at the negative tail, so it is a one-sided confidence level. For example, 99% confidence level would be equal to 2.33. $\endgroup$ – AK88 Nov 25 '19 at 13:27
  • $\begingroup$ Why would it be incorrect to calculate the 99% VaR by first taking the absolute values of the 500day p&l vector, and then calculating the 99% worst case scenario? $\endgroup$ – One Pablo Nov 25 '19 at 14:15
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    $\begingroup$ It is not incorrect, it is about how informative is this number. If you are looking at history and saying that this is how much we could lose, then it is fine. However, if you are doing a forward looking analysis, then this may not always hold true. $\endgroup$ – AK88 Nov 25 '19 at 14:50

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