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Hi John,
Sorry, I need to rephrase. VAR is positive but it is higher than the average.
It was in an example in the BPP textbook whereby NPV for 4 years is $2mil and standard deviation for 1 year is $1mil.
At 95% confidence level for the 4 years, it is 1.645 * $1mil * square root of 4 = $3.29m.
Using $2mil to deduct $3.29m, I get -$1.29m. Does this mean that I am 95% confident that the return will be a loss of $1.29m and there is less than 5% chance that the loss will be greater than $1.29m?
It seems that the BPP textbook is a bit confused if you have cop[ied from there correctly.
We use VaR on the annual net flow, not on the NPV.
So if there were a return of $2m per year for 4 years, then the total average return would be $8M.There is a 5% chance therefore of the total return being less than 8 – 3.29 = $4.71M.
Have you watched my free lectures on VaR?
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