Here is a an Excel widget I built for converting a Sharpe Ratio to a Daily VaR. This is helpful for a trader or asset allocator who thinks in terms of Sharpe's which are annual units of risk to reward and having to provide a daily Value at Risk measure.
To use this widget, after downloading the excel file:
- Move the scroll bar to reflect your Annual expected/historical return - Risk Free Rate
- Move the Scroll bar to reflect your annual standard deviation. In Excel= Standard Deviation of Daily returns * (Number of Trading days/year ^.5)
- Move the VaR Daily limit to reflect the VAR threshold you are comfortable with
- Move the VAR threshold to reflect the confidence or (rate of occurance) you would be comfortable with violating that threshold.
You will see the #of days annually that the threshold will be violated and the annual returns expected.
All the usual VaR caveats apply. The assumptions being a normal distribution in the generating process which never holds true and the fact that VaR tells you how often you will fall off a $ cliff, but not how far you are going to fall. Caveat emptor. I am not a big fan of VaR as people tend to get hung up on it. For true buy and hold investing it just plain doesn't make any sense to use at all.
For a quant trading approaches VaR is an OK starting point but for a buy and hold or value based portfolio, I put Beta and VaR in the same bucket. Both are silly and dangerous. VaR of course does little if you have a major gamma risk or high convexity low event type of risk embedded in a portfolio or approach. It can be argued that a pure Stat-arb has a gamma approach similar to selling premium, but that is another topic for another day.
Book Recommendation of the Day. Excel Hacks