VAR, Value at Risk, and Stress Test

Flashcards about finance terms and concepts discussed in the lecture.

VAR

A measure of variability in finance, also stands for Value at Risk and Vector Autoregressive.

Value at Risk (VAR)

A measure used in finance to quantify the risk of an investment or portfolio, quoted in dollars for a given probability and time horizon.

There's a 1% chance the portfolio will lose $10,000,000 in one year.

What does a 1% one-year value at risk of $10,000,000 suggest?

Stress Test

A method of assessing risk to firms or portfolios by examining vulnerabilities to various kinds of financial crises.

What's the idea of a stress test?

Reflects the idea to look at a portfolio not just by its historical returns and how variable they are, but to look at the details and ask what vulnerabilities there are for various kinds of financial crises.

Dodd Frank Act of 2010

Legislation passed in response to the 2007-2008 financial crisis, requiring the Federal Reserve to conduct annual stress tests for non-bank financial institutions.

An organization created in 2011 that instituted regular stress tests for European banks.

What is the European Banking Authority?

There's skepticism about whether they can accurately predict outcomes in the next financial crisis due to underestimation of events.

What is a concern about government stress tests?

Negative results could damage their reputation and deter other companies from doing business with them.

Why might a firm be hesitant to publicly release the results of an internal stress test?

The Office of Financial Research gained subpoena power to demand information from firms.

What power did the Dodd Frank Act give regulators regarding stress tests?