When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the ____

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BlackTom AI · Accepted Answer

Understanding the concept in question requires unpacking what VaR at the 5% tail represents. 
Option D: 'most optimistic as it takes the highest return (smallest loss) of all the cases.' This is incorrect because VaR at the 5% tail concerns the loss level that will not be exceeded in the worst 5% of cases, i.e., it focuses on large losses, not on the highest return or smallest loss across scenarios. Calling it the most optimistic mischaracterizes its purpose. 
Option B: 'most pessimistic as it is the most complete measure of risk.' This is the closest to a sensible critique of VaR: VaR emphasizes potential losses in the tail and is inherently pessimistic about downside risk. However, it is important to note that VaR is not necessarily the most complete measure of risk because it does not capture how bad losses can be beyond the VaR threshold. Still, relative to the options, this statement captures the pessimistic orientation of VaR more accurately than the others. 
Option C: 'most optimistic as it is the most complete measure of risk.' This is incorrect on two counts: VaR is not optimistic, and it is not the most complete measure of risk (it omits tail severity beyond the threshold). 
Option A: 'most realistic as it is the most complete measure of risk.' This is misleading: while VaR is a widely used risk metric, it is not universally considered the most realistic or the most complete, since it ignores tail magnitude beyond the cutoff and can underestimate risk in heavy-tailed distributions. 
In summary, option B most closely aligns with the fundamental idea that VaR at the 5% tail emphasizes downside risk (pessimistic orientation), while the other statements misstate what VaR measures or exaggerate its comprehensiveness or realism.}

BU.232.750.81.FA25 Final Exam Fall 2025- Requires Respondus LockDown Browser

When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the ____

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