Brian, of course you are correct. The reason the normal is used (here and often) is merely to introduce VaR as the quantile of a distribution (i.e., any distribution!) … those normal is friendliest to the new learner…once we explain how VaR is “merely a quantile” then we can deal in the various approaches, parameteric or otherwise…although re: power law & heavy-tail distributions, you still have the issue of “does any parametric distribution” *really* fit the tail? David
The Gaussian has proven to be a terrible predictor of extreme events in this context, and other methods (like using a “power law” or a polynomial with scale invariance) have been much more accurate. What gives?
I am a casual student of econ/finance, and this has always perplexed me.
If the normal distribution is so clearly an false assumption for the distribution of many different types of asset returns, does mathematical expediency truly make its use necessary? Why not use (at least) a “fat-tailed”, or even a skewed (asymmetrical) variant as the standard density function for financial practice, depending on the historical data?
And I agree, I am showing the so-called absolute VaR without reference to the mean; which is sort of okay for short trading (daily or less) periods. But yours (so-called relative VaR) is just better as it is the general case and treats VaR as the unexpected loss. Thanks for making this point!
Thanks for posting these videos. I’d like to point out one oversight in this illustration. When the mean is non-zero (here, it is -0.71%), you must take it into account. So in your spreadsheet, C18 should =C14+C16*C17.
Of course, the mean is commonly approximately zero and can be ignored, but in this example it’s worth including.
Thanks again for posting these videos, they are useful!
All righty… Now my mind is settled..
I have burned the midnightoil here in Denmark whit thiese sort of issues the last 2 weeks.. And its great 2 watch someone else practise thiese issues, so I can see it from anohter proff.s point off wiev… So you just keep doing the fine job…
Salut from DK….
Hi Mahyar: History informs params but that’s all: it gives us average & volatility. But then I don’t use history, i.e., for normal (parameteric) distribution. I use only the smooth (but unrealistic) curve. A HISTORICAL SIM has NO params. For historical sim, you only need to SORT the historical return and look down the list to 95th-99th %ile, etc. You have a point, under most VaR approaches, historical series at least implicitly informs going-forward model. Thanks for viewing!
Hello mister David..
I have difficult to differ the delta normal approach from the historical distribution..
The pracsis you are performing in this video is much alike the historical distribution??
David, thank you! Simplification of the complex things makes me understand quant finance.
Also could tell me please how to create a chart of density in Excel?
Sashaeagle
5 Feb 10 at 2:41 pm
Brian, of course you are correct. The reason the normal is used (here and often) is merely to introduce VaR as the quantile of a distribution (i.e., any distribution!) … those normal is friendliest to the new learner…once we explain how VaR is “merely a quantile” then we can deal in the various approaches, parameteric or otherwise…although re: power law & heavy-tail distributions, you still have the issue of “does any parametric distribution” *really* fit the tail? David
bionicturtledotcom
5 Feb 10 at 2:46 pm
Samran, belatedly: thank you for liking the videos! David H
bionicturtledotcom
5 Feb 10 at 2:53 pm
The Gaussian has proven to be a terrible predictor of extreme events in this context, and other methods (like using a “power law” or a polynomial with scale invariance) have been much more accurate. What gives?
briano8713
5 Feb 10 at 3:03 pm
I am a casual student of econ/finance, and this has always perplexed me.
If the normal distribution is so clearly an false assumption for the distribution of many different types of asset returns, does mathematical expediency truly make its use necessary? Why not use (at least) a “fat-tailed”, or even a skewed (asymmetrical) variant as the standard density function for financial practice, depending on the historical data?
briano8713
5 Feb 10 at 3:42 pm
Dear Mr. Harper,
I am really a great fan of yours. I have really learned a lot from these sort of videos from you.
Please keep uploading these, I have recommended many friends of that.
Thanks n Regards,
Samran Habib
Dubai
UAE
social90climber
5 Feb 10 at 4:25 pm
Statistical functions are available in excel.
arihant11
5 Feb 10 at 4:43 pm
I have question. How did you draw that normal distribution graph in the excel?
mport365
5 Feb 10 at 5:13 pm
Thanks Aviad, I appreciate that.
And I agree, I am showing the so-called absolute VaR without reference to the mean; which is sort of okay for short trading (daily or less) periods. But yours (so-called relative VaR) is just better as it is the general case and treats VaR as the unexpected loss. Thanks for making this point!
David
bionicturtledotcom
5 Feb 10 at 5:18 pm
David,
Thanks for posting these videos. I’d like to point out one oversight in this illustration. When the mean is non-zero (here, it is -0.71%), you must take it into account. So in your spreadsheet, C18 should =C14+C16*C17.
Of course, the mean is commonly approximately zero and can be ignored, but in this example it’s worth including.
Thanks again for posting these videos, they are useful!
Aviad
earth1ing
5 Feb 10 at 6:14 pm
I liked it. Very informative staff.
Arteaisgoodman
5 Feb 10 at 6:44 pm
All righty… Now my mind is settled..
I have burned the midnightoil here in Denmark whit thiese sort of issues the last 2 weeks.. And its great 2 watch someone else practise thiese issues, so I can see it from anohter proff.s point off wiev… So you just keep doing the fine job…
Salut from DK….
figifigi23
5 Feb 10 at 7:35 pm
Hi Mahyar: History informs params but that’s all: it gives us average & volatility. But then I don’t use history, i.e., for normal (parameteric) distribution. I use only the smooth (but unrealistic) curve. A HISTORICAL SIM has NO params. For historical sim, you only need to SORT the historical return and look down the list to 95th-99th %ile, etc. You have a point, under most VaR approaches, historical series at least implicitly informs going-forward model. Thanks for viewing!
bionicturtledotcom
5 Feb 10 at 8:17 pm
Hello mister David..
I have difficult to differ the delta normal approach from the historical distribution..
The pracsis you are performing in this video is much alike the historical distribution??
Mahyar, Denmark.
figifigi23
5 Feb 10 at 8:57 pm
cool brow…
figifigi23
5 Feb 10 at 9:48 pm
Nice brow…
figifigi23
5 Feb 10 at 9:52 pm