Value at Risk (VaR)

Value at Risk is a statistical technique used to measure the level of financial risk within a firm or investment portfolio over a specific time frame. It estimates the maximum potential loss that a portfolio could incur with a given confidence level under normal market conditions.

For instance, a one-day 95 percent VaR of 10,000 dollars means there is a 95 percent chance the portfolio will not lose more than 10,000 dollars in a single day. In cryptocurrency, VaR is notoriously difficult to calculate because returns often exhibit fat tails and extreme volatility, which standard models frequently underestimate.

Derivatives desks use VaR to determine capital allocation and set position limits for traders. However, VaR does not account for losses beyond the confidence threshold, which is why stress testing is used alongside it.

It provides a single number that summarizes the aggregate risk exposure of complex trading positions.