Companies that are part of the “real” economy can barely assess their risk of business activities with the VAR approach. They would rather want to know the shortfall of their expected cash flows.

Example: we expect cash flows of $10m over the next year, their volatility is $3m.

Thus, there is a 5% chance that cash flows fall below $5.05m (10-4.95) in the next year.

Assumptions:

  • cash flows are normally distributed
  • we know their volatility
  • this volatility is constant for the period in question