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BPP AFM workbook page 60 state a Drawback of value at risk is:
Value at risk is based on a normal distribution, which assumes that virtually all possible outcomes
will be within three standard deviations of the mean and that “success and failure are equally
likely”.
I do not understand the sentence “success and failure are equally likely” and why it is a drawback of value at risk method?
Please give me more explanantion.This is a poor explanation by BPP.
What they. should have said is that the normal distribution is symmetrical and therefore the probabilities of the outcome being higher than the average and being lower then the average are the same.
The real problems with VaR is the assumption that the results do follow a normal distribution (they might not) but more importantly than even if there is (for example) only a 1% probability of too great a loss this could still happen and could bankrupt the business.
I do suggest that you watch my free lectures on this. It is covered in the lectures working through Chapter 10 of our free lecture notes.
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