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## Monday, June 28, 2010

### VaR -- estimating portfolio value if there's a downtown

Anil,

Let me rephrase my last question at Newark. Say our IBM position has current market value of \$1m. We want to know the likelihood of losing more than 100k in the next 2 weeks. We can use IBM stock volatility stats to compute the likelihood to be... say 5.5%. Meaning we have a 5.5% chance of losing \$100k or more in 2 weeks.

Now the portfolio holds SUN stocks too. Current MV = 1m of IBM + 2m of SUN = 3m. What's the likelihood of losing \$300k+?

First assume SUN and IBM are unrelated. The volatility of the portfolio can be computed based on the 2 volatility stats. We can then derive the likelihood of losing \$300k+ as ... say, 6%. We have a 6% chance of losing 300k ore more in the next 10 days.

In reality IBM and SUN stocks are correlated. I guess portfolio volatility can be adjusted based on the covariance.

Option valuation volatility is very similar to stocks, i guess? Reason -- Probability distribution curve is very similar?

Makes sense?