Relative and Absolute VAR

[Maximus_FRM2012]

Hi David,

Looking through your notes, I think there are cases where the definition for relative and absolute are contradictory.

In Topic 7 for LVAR, your notes (p.23) the example and description of Relative VAR is:
not to include the expected return and just use the volatility times the deviate.

However in Topic 8 for SAR (p.26), you have Relative SAR as:
including the expected return plus the volatility times the deviate

Are the two writers contradicting themselves or is there something that I a missing?

Maximus

 

[David Harper CFA FRM]

Hi Maximus,

I do not agree that P26 or p27 defines relative SaR to include the expected return. Where?

Relative VaR is always the VaR relative the future expected value, and will therefore exclude expected return (unless expected return is somehow informs the dispersion in the future which is atypical).

As absolute market risk VaR% = -drift*time + sigma*sqrt(T)*deviate,
relative VaR is the special case where the drift = 0 and so relative (market risk) VaR% = sigma*sqrt(T)*deviate.

In the case of surplus at risk (p 26 and p 27), relative SaR = $218.68 = 9.4% volatility * $1,000 assets * 2.33 deviate; i.e., Jorion's example in Chapter 17.

Now, absolute SaR in the context of surplus at risk (SaR) clearly has (at least) two different definitions; e.g., http://forum.bionicturtle.com/threads/p2-t8-12-surplus-at-risk-sar.5488/#post-21233

We have submitted this to GARP ...

But for the exam, please do not let surplus at risk (SaR) which is a minor topic, distract from the truth of absolute/relative VaR that is accurately portrayed (eg.) by Dowd's LVaR. Good luck on the exam! Thanks,