Ch 17 problem 17.11 What difference does it make to the Var calculated in Example 17.2 if the exponentially weighted moving average model is used to assign weights to scenarios as described in Section 12.3?
Suppose that, in the example in Section 12.1, five stressed scenarios are considered. They lead to losses($000s) of 235, 300, 450, 750, and 850. The subjective probabilities assigned to the scenarios are 0.5%, 0.2%, 0.2%, .05% and.05% respectively. The total probability of the stressed scenarios is, therefore, 1%, This means that the probability assigned to the scenarios generated by historical simulation if 99%, Assuming the equal weighting is used, each historical simulation scenario is assigned a probability of .99/500 =.00198. The probabilities assigned to scenarios are accumulated from the worst scenario to the best. The Var level when the confidence level is 99% is the first loss for which the cumulative probability is greater than.01. in the our example this is $300,000