Valuation & risk models

Value at Risk (VaR) only measures the minimum loss at a specific confidence level, failing to describe the severity of losses in the tail beyond that threshold. Expected Shortfall (ES) is often used instead because it calculates the average of these extreme tail losses. Distractors like C are incorrect because VaR can be readily calculated using historical or Monte Carlo methods.

Expected loss is calculated as the product of the probability of default, exposure at default, and loss given default, representing the average anticipated credit loss. Distractors proposing additive or subtractive relationships are incorrect because these components must be multiplied to scale the loss proportionally.

Value-at-Risk at a 95% confidence level estimates the threshold loss that is expected to be exceeded only 5% of the time over a one-day period. A diagram for this topic isn't available yet — the worked example below walks the same reasoning step by step.

• !Distractors proposing additive or subtractive relationships are incorrect because these components must be multiplied to scale the loss proportionally.
• !Value at Risk (VaR) only measures the minimum loss at a specific confidence level, failing to describe the severity of losses in the tail beyond that threshold.

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