Volume 3 — Valuation and Risk Metrics © Copyright 2002, CCRO. All rights reserved. 17 Figure 2c. Histogram of VaR Less MTM Trading Gains and Losses, Calculated Daily Number of Trading Days 15 10 5 0 0 2040 4060 6080 020 In Millions Positive Negative Positive Negative 3.4 Applicability VaR provides a summary measure of market risk and can be represented as a single number. However, in certain instances VaR is not a good measure, as illustrated in Table 2. Table 2. Applicability of VaR What VaR Can Tell Us What VaR Cannot Tell Us • The primary purpose of VaR is to measure market price risk. • VaR may be used in risk reporting to notify management and stakeholders of the risks involved in trading operations at a given point in time. • VaR is used to allocate risk resources among traders or strategies. • VaR measures changes in MTM value. • Adjusting performance based on VaR sends correct signals to the trading function. For example, if one trader can make $3 million while risking only $100,000 per day while another trader makes $3 million risking $1 million per day, the first trader had much better performance. Performance is evaluated as returns to risk rather than strict dollar returns. • VaR does not indicate the maximum a company can lose – only the maximum a company is likely to lose under current market conditions. VaR does not measure volumetric risk, financial stability, or operational risk. • VaR does not report profitability, return on investment, or revenue loss. However, it can be a component in determining the “risk- adjusted” value of the portfolio. • VaR is only a statistical approximation and not an exact result. • VaR cannot predict the worst loss, nor does it capture accumulated losses. • VaR is not an all-encompassing measure for trading performance and has meaning only if the company’s management has established a risk tolerance in accordance with governance guidelines.