What is the Variance/Covariance Matrix or Parametric method?
This is a very simplified and speedy approach to VaR computation. It is so, because it assumes a particular distribution for both the changes in market prices and rates and the changes in portfolio value. Usually, this is the “normal” distribution. The neat thing about the normal is that a lot is known about it, including how to readily obtain an estimate of any percentile once you know the variances and covariances of all changes in position values. These are normally estimated directly from historical data. In this method the VaR of the portfolio, is a simple transformation of the estimated variance/covariance matrix. So simple that it doesn’t really work well for nonlinear positions.
