Cracking VAR with kernels
Value-at-risk analysis has become a key measure of portfolio risk in recent years, but how can we calculate the contribution of some portfolio component? Eduardo Epperlein and Alan Smillie show how kernel estimators can be used to provide a fast, accurate and robust estimate of component VAR in a simulation framework
The notion of component value-at-risk (CVAR) originated in the papers of Garman (1996, 1997) and Litterman (1997a, 1997b), and has been used by banks as a practical risk analysis tool since at least Epperlein & Sondhi (1997). The goal is to calculate how much some component of a portfolio contributes to the total VAR of that portfolio. We denote the profit and loss (P&L) of the portfolio as PL and the P&L of the ith component as PLi, so that:
- from a simulated sample. If we are willing to
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