Financial institutions face financial risks that can be staggering. Avoiding the worst of these risks and managing the unavoidable risks remaining requires the institution's constant informed vigilance. But until recently, there has been little consensus about the most fundamental issue of all: How is risk to be measured? Although there can be no perfect answer applicable in all institutions, there has recently emerged a consensus supporting a way of measuring risk that is relatively easy to understand, readily available in many contexts, and which is reasonably accurate. This measure is called Value at Risk, which measures the potential for loss in value of a specified portfolio for a given holding period. VaR has been endorsed as a risk measure by such groups as the Basle Committee on Banking Supervision, the Bank for International Settlements, the Derivatives Policy Group.
The purpose of this paper is to describe a variety of different methods that can be used to arrive at estimates of VaR and to discuss their advantages and disadvantages. In addition, this paper shows that the formal procedures that would typically be used in performing VaR verification tests and the strengths and weaknesses of these methods. Because of given their function both as internal risk management tools and as potential regulatory measures of risk exposure, it is important to quantify the accuracy of an institution's VaR estimates.
Meantime Korean banks are now on the verge of introducing VaR systems to their risk management systems. So, our bank regulators should establish the supervision standards in respect to capital requirements, derivatives transactions, internal control system and early warning system on the unexpected emergency in the international context.
