Exploring the Limitations of Value at Risk: How Good Is It in Practice?

Abstract

The benefits of value at risk (VaR) are its simplicity and broad applicability. However, the limitations of VaR are only just being openly discussed by researchers and practitioners. This article provides a brief review of problems faced when applying VaR as a risk management tool. The author shows that VaR is not always a good risk measure and is often prone to substantial measurement error. The author concludes that VaR remains a useful risk management tool when appropriately applied with an understanding of its limitations.