Value at Risk
Most companies are exposed to the fluctuating prices of commodities. We all know that we risk “something” due to the price fluctuations of commodities. But we don’t know how BIG this risk is for our particular company. We need a single measure to quantify this, so that management can relate to this risk. The VaR concept was originated by JP Morgan in 1994 and is today widely used as a risk management tool. It is a pure statistical measure which adds up risks from all asset classes to one single measure. It is designed to answer a question from a concerned top management: "We know we can loose a lot of money in the raw materials market. Tell me with one figure how big our maximum risk is?"
How to use
Please input your yearly purchasing amount in Euros for the different commodities. The result shows what kind of risk exposure your company has from these commodities. The result can generally be interpreted as: “We are 95% percent certain that our portfolio will not lose more than “X” Euros on a yearly basis. If the Portfolio VaR result is for example 5 million Euros, then we are 95 percent sure, that the loss due to fluctuating commodity prices will not exceed 5 million Euros within the next year. But you must be aware that the maximum loss in 5 out of 100 times can exceed 5 million Euros.
Try the free VaR model
Disclaimer
Please be aware of that the above shown calculations are static and not updated on a regular basis. The above shown measure should therefore only be seen as an appetizer and not as a pure risk management tool. A complete risk management tool requires a lot more work and details regarding the company’s exposure and the underlying commodities.
The concept relies heavily on the assumptions that financial returns are normal distributed and uses volatility and correlations between the different asset classes. Further, the VaR measure does only perform well under normal market circumstances, i.e. not under the current credit turmoil.
As a default setting we have chosen the confidence level as 95% and the time horizon to 1 year.