Which of the following is a disadvantage of VAR?

Value at Risk (VAR) is a widely used risk management tool that estimates the potential loss in value of an asset or portfolio over a specified time period for a given confidence interval. One of the key disadvantages of VAR is that it often underestimates the magnitude of risk, particularly in extreme market conditions. This underestimation can occur because VAR typically relies on historical data and assumes that past market behavior will continue into the future, which may not hold during periods of market stress or abnormal volatility. Additionally, VAR does not capture the tail risk — the risk of extreme loss that exceeds the VAR threshold — which can be significant during market downturns. Therefore, while VAR can provide useful insights into potential losses, its limitations mean that it should not be the sole measure of risk and should be complemented with other risk assessment methods.