This section needs a detailed explanation. VaR is computed using exponentially weighted moving average (EWMA) methodology. Based on statistical analysis, 94% weight is given to volatility on ‘T-1’ day and 6 % weight is given to T day return [Please read ‘NSE Quotes – Different types of Margins/Volatility’ for clear understanding of volatility].
Tday return is computed as LN(Today’s Close Price/Yesterday’s Close price)
Take the volatility calculated on T-1 th day and apply the following formula to get T day’s volatility.
Square Root of [0.94 * T -1 day’s volatility *T -1 day’s volatility + 0.06 *T day’s return * T day’s return ]
Take an example to calculate VaR.
Share of XYZ Ltd
Volatility on July 1, 2008 = 0.0314
Closing price on June 30, 2008 = Rs. 360
Closing price on July 1, 2008 = Rs. 330
Return on July 1st = LN (330/360) = 0. 08701 Assume volatility on June 30th is 0.0314 which was calculated by the same procedure.
July 1, 2008 volatility =Square root of [(0.94*(0.0314)*(0.0314) + 0.06 (0.08701)* (0.08701)] = 0.037 or 3.7%
Now to calculate VaR companies are divided into 3 categories based on how regularly their shares trade and on the basis of liquidity
Group I consists of shares that are regularly traded (that is, on more than 80% of the trading days in the previous six months) and have high liquidity (that is, impact cost less than 1%).
Group II consists of shares that are regularly traded (again, more than 80% of the trading days in the previous six months) but with higher impact cost (that is, more than 1 %).
All other shares are classified under Group III.
Impact cost is defined as by how much a large buy or sell order changes the price of the scrip.
VaR Margins for Group I category is the higher of
• 3.5 times volatility or • 7.5% of the position (Buy or Sell)
That is the value obtained by multiplying 3.5 with volatility is less than 7.5% then VaR is 7.5% else the calculated value is taken as VaR. That is minimum VaR for this category is 7.5 %.
For Group II shares, the VaR margin is calculated as below.
First higher of the following is considered
• 3.5 times volatility or • 3.0 times volatility of index
The volatility of index is taken as the higher of the daily Index volatility based on S&P CNX NIFTY or BSE SENSEX. At any point in time, minimum value of volatility of index is taken as 5%.
VaR is higher of the above values multiplied by 1.732051 (Square Root of 3).
For Group III securities VaR margin rate would be 5.0 times volatility of the Index multiplied by 1.732051 (square root of 3).
In the example we considered if XYZ Company belongs to Group 1 then 3.5 * 3.7 = 13 % is the VaR.
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Sathish Emmadi
Sathish Emmadi is a co-founder & editor at Lastbull.com. He is presently working in IT for one of the world’s top mutual fund companies. Handled multiple projects in BFSI (Banking,Financial Services and Insurance) domain. An Engineering Graduate from NITW.
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