Why does the curriculum state that measuring credit VAR requires focusing on the upper distribution of market returns, and that is is based on gains on market positions held? The quote is below, and the page number is 250 in Risk Management Book.
“Like ordinary VAR, it reflects the minimum loss with a given probability during a period of time. A company might, for example, quote a credit VAR of €10 million for one year at a probability of 0.05 (or a confidence level of 95 percent). In other words, the company has a 5 percent chance of incurring default-related losses of at least €10 million in one year. Note that credit VAR cannot be separated from market VAR because credit risk arises from gains on market positions held. Therefore, to accurately measure credit VAR, a risk manager must focus on the upper tail of the distribution of market returns, where the return to the position is positive, in contrast to market risk VAR, which focuses on the lower tail. Suppose the 5 per- cent upper tail of the market risk distribution is €5 million. The credit VAR can be roughly thought of as €5 million, but this thinking assumes that the probabil- ity of loss is 100 percent and the net amount recovered in the event of a loss is zero. Further refinements incorporating more-accurate measures of the default probability and recovery rate should lead to a lower and more accurate credit VAR.”
“Like ordinary VAR, it reflects the minimum loss with a given probability during a period of time. A company might, for example, quote a credit VAR of €10 million for one year at a probability of 0.05 (or a confidence level of 95 percent). In other words, the company has a 5 percent chance of incurring default-related losses of at least €10 million in one year. Note that credit VAR cannot be separated from market VAR because credit risk arises from gains on market positions held. Therefore, to accurately measure credit VAR, a risk manager must focus on the upper tail of the distribution of market returns, where the return to the position is positive, in contrast to market risk VAR, which focuses on the lower tail. Suppose the 5 per- cent upper tail of the market risk distribution is €5 million. The credit VAR can be roughly thought of as €5 million, but this thinking assumes that the probabil- ity of loss is 100 percent and the net amount recovered in the event of a loss is zero. Further refinements incorporating more-accurate measures of the default probability and recovery rate should lead to a lower and more accurate credit VAR.”