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nism-series-xv-value-at-risk-var-99-confidence-interpretation[ RESEARCH ANALYST ]

If an investment portfolio has a 1-day Value at Risk (VaR) of Rs. 5,00,000 at a 99% confidence level, what does this statistical risk metric specifically signify?

[ A ]The portfolio is guaranteed to earn exactly Rs. 5,00,000 in trading profit every single day.

[ B ]The portfolio has completely lost 99% of its total investment capital in the previous 24 hours.

[ C ]There is a 99% probability that the portfolio's maximum loss over a 1-day horizon will not exceed Rs. 5,00,000 (i.e., only a 1% chance that daily loss will exceed Rs. 5,00,000 under normal market conditions).[ CORRECT ]

[ D ]The investor must pay a mandatory tax fine of Rs. 5,00,000 to the stock exchange every morning.

Takeaway

Option C is correct: There is a 99% probability that the portfolio's maximum loss over a 1-day horizon will not exceed Rs. 5,00,000 (i.e., only a 1% chance that daily loss will exceed Rs. 5,00,000 under normal market conditions).

Derivation

Value at Risk (VaR) is a widely used probabilistic risk metric that quantifies the maximum expected loss of a portfolio over a specified time horizon at a given statistical confidence level. A 1-day VaR of Rs. 5,00,000 at a 99% confidence level means that under normal market trading conditions, the investor can be 99% confident that the daily portfolio loss will not exceed Rs. 5,00,000. In statistical terms, there is only a 1% probability (significance level = 100% - 99%) that losses will surpass Rs. 5,00,000 on any given day. This tests VaR interpretation. The common error is misinterpreting VaR as guaranteed profit.

Why the others fail

A — The portfolio is guaranteed to earn exactly Rs. 5,00,000 in trading profit every single day.

VaR measures potential downside monetary loss risk, not guaranteed daily positive trading profits or cash inflows.

B — The portfolio has completely lost 99% of its total investment capital in the previous 24 hours.

99% is the statistical confidence interval of the risk model, not the actual percentage of capital lost.

D — The investor must pay a mandatory tax fine of Rs. 5,00,000 to the stock exchange every morning.

VaR is an internal statistical risk calculation used for risk management and capital provisioning, not a government tax fine.