Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

Which statement regarding value at risk (VaR) is least accurate?

1. Short-term fund histories tend to make VaR analysis problematic for private equity.

2. The confidence level will be between 0 and 0.10.

3. Measuring the likelihood of extreme gains and losses is a goal of VaR analysis.

4. Normal economic conditions are assumed when calculating VaR.

The correct answer is: The confidence level will be between 0 and 0.10.

The statement about the confidence level being between 0 and 0.10 is least accurate regarding value at risk (VaR). In practice, the confidence levels used in VaR calculations are typically set at higher thresholds, commonly ranging from 90% to 99%. This range reflects a greater interest in understanding potential losses in a more serious or extreme context, rather than a lower confidence level that would imply a very narrow and less informative range of risk assessment. In contrast, the other statements accurately describe aspects of VaR. The challenges that short-term fund histories present in assessing VaR for private equity relate to the illiquid and volatile nature of private equity investments, complicating the calculations. The goal of measuring the likelihood of extreme gains and losses aligns with VaR's purpose of identifying risk factors in a portfolio. Lastly, the assumption of normal economic conditions when calculating VaR highlights the method’s reliance on historical data and typically normal market behavior, which can overlook the impact of extreme market fluctuations.