Beta can be estimated by doing regression analysis of past historical data. Normally beta would be very close to 1.

When we do not account for gamma effect, we overstate the VAR. gamma like convexity helps long party and is adversial to the short party.

Callable bond has both positive as well as negative convexity.the negative convexity should be subtracted from duration approximate and the positive convexity at high yields should be added to the duration approximate.

When the shape of the curvature itself changes both delta and gamma cannot come to our rescue to give us either the price or the VAR approximations. For such complex payoffs we need to use monte carlo simulation techniques.

Crisis event creates a contagion effect and correlation between assets starts rising to 1. If the covariance matrix fed to SMC was in normal times it may not be able to give a proper estimate of VAR and may understate it, because of increased correlations between the assets the diversification benefits have dried away.

For computing complex payoffs such as straddle we need to use SMC method as traditional Delta-Gamma methodologies won’t work.

Stress testing-

VaR should be complemented with stress testing. This involves testing the model when all the parameters start moving adversely against our position simultaneously.

To build stress test parameters we can look at historical data and develop scenarios such as worst case scenarios, best case scenarios etc.

Worst case scenario-all stress parameters taken to their worst possible limits.