How can Value at Risk apply to trading? Say, I calculated a VaR figure of $100, but the daily loss is often larger than the threshold of $100. What can I do now with the VaR model? To adjust the trading or the model? Thanks.
First, you learn what you are talking about. > Say, I calculated a VaR figure of $100, but the daily loss is often > larger than the threshold of $100. No, you calculated VAR of USD 100 with a certain pbability and horizon. If you are often above it then either your parameter are wrong, or you have simple a wrong formula. If you calculate ta 1 hour VAR horizon, then naturally the daily loss will often be higher. If you calculate a 80% horizon, then one of 5 days will be outside, even without black swan type event. Second, it is useful as a generic measurement of how much risk you ahve, not as the all end of risk management (as the outlier will come nad kill you - have a 95% var, that is 5% outside, and out of that some small 0.5% will be NASTY). But a VAR has alyways 2 parameters - percentage and time horizon. http://en.wikipedia.org/wiki/Value_at_risk has some explanations.
I mean if the VaR figure is $100, and my loss is often larger than that threshold. Then what to do? To recalculate or to stop trading? What is the value of VaR application in the real trading? Thanks.
The VAR figure is not 100$. It is 100% WITH A CERTAIN PERCENTAGE TO BE BROKEN. Naturally yous hould be conservative and calcualte the figure so that it pleases what you need. Obviously it is broken OFTEN, you blindly use a statistical number without trying to understand what it means.