What is the difference between absolute VaR and relative VaR?

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AcadiFi · Accepted Answer

Absolute VaR measures the potential loss in dollar terms from the current portfolio value, while relative VaR measures the loss relative to the expected value at the horizon. If a portfolio is worth $10M today with expected drift of $200K over the horizon, absolute VaR at 99% might be $800K (from $10M) and relative VaR might be $1M (from $10.2M). The gap widens as the horizon lengthens because expected drift compounds. Short-horizon VaR (one day) makes the distinction almost meaningless — drift is negligible — so banking regulators typically ignore it. For monthly or quarterly capital calculations, the choice matters. Basel market risk rules historically used absolute VaR because it directly matches reported P&L, whereas portfolio managers benchmarked against a target return often prefer relative VaR. Think of absolute as 'how much cash could I lose' and relative as 'how badly could I miss my plan'. ```mermaid flowchart LR P[Value today
$10M] --> A[Absolute VaR
loss from $10M] P --> D[Drift +$200K] D --> R[Relative VaR
loss from $10.2M] ``` The practical rule: match the VaR definition to the decision. Trading desks report absolute; asset-liability teams often use relative.

What is the difference between absolute VaR and relative VaR?

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