What does the value at risk measure indicate?

Value at Risk (VaR) is a statistical measure used to assess the risk of loss on an investment portfolio. Specifically, it quantifies the level of potential loss that is not expected to be exceeded over a defined period for a given confidence interval. For example, if a portfolio has a one-day VaR of $1 million at a 95% confidence level, it indicates that there is only a 5% chance that the losses will exceed $1 million in one day.

This metric is valuable for risk management as it helps financial professionals understand the potential downside and prepare for adverse market movements. It does not provide information about the total capital of an investment portfolio, the probability of earning a certain return, or the level of leverage used in trading, focusing instead solely on potential losses within a specified timeframe and confidence level. This makes VaR a critical tool for risk assessment and informing investment decisions.