Normal Distribution and Standard Deviation for a Portfolio. Value At Risk (VaR) explained. CFA exam

Описание: In this video, I cover the normal distribution as it relate to a portfolio. Normal distributions are important in statistics and finance in terms of portfolio analysis.
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Prerequisite:
   • Chapter 5: Risk, Return, and the Historica...  


The normal distribution is central to the theory and practice of investments. Its familiar bell-shaped plot is symmetric, with identical values for all three standard measures of “typical” results: the mean (the expected value discussed earlier), the median (the value above and below which we expect 50% of the observations), and the mode (the most likely value).

Standard deviation measures the dispersion of possible asset returns. But suppose you are worried more specifically about large investment losses in worst-case scenarios for your portfolio. You might ask: “How much would I lose in a fairly extreme outcome, for example, if my return were in the fifth percentile of the distribution?” You can expect your investment experience to be worse than this value only 5% of the time and better 95% of the time. In investments parlance, this cutoff is called the value at risk (denoted by VaR, to distinguish it from Var, the common notation for variance). A loss-averse investor might desire to limit portfolio VaR, that is, limit the loss corresponding to a particular threshold probability such as 5%. The most common probability thresholds used for VaR analysis are 5% and 1%.

value at risk (VaR)

Measure of downside risk. The worst loss that will be suffered with a given probability, often 1% or 5%.