Prudential 2003 Annual Report Download - page 95
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credit spreads, foreign exchange rates, equity prices and commodity prices, estimates of volatilities from historical
data, the sensitivity of our trading activities to changes in those market factors and the correlations of those factors. We
regularly test our VaR model by comparing actual adverse results to those estimated by the VaR model with a 95%
confidence level over a one-day time horizon. The VaR for our trading activities expressed in terms of adverse changes
to fair value at the 95% confidence level over a one-day time horizon was $2 million as of December 31, 2003 and $2
million as of December 31, 2002. The average daily VaR for our trading activities, expressed in terms of adverse
changes to fair value with a 95% confidence level over a one-day time horizon, was $2 million during 2003 and $4
million during 2002. The following table sets forth a breakdown of this VaR by risk component as follows:
As of
December 31,
2003
Average for
2003
As of
December 31,
2002
Average for
2002
(in millions)
Interest rate risk ..................................................... $ 1 $ 2 $ 2 $ 4
Equity risk ......................................................... — — — —
Commodities risk .................................................... 1 — — —
Total(1) ....................................................... $ 2 $ 2 $ 2 $ 4
(1) As of December 31, 2003 and 2002, and during the years then ended, VaR from foreign currency exchange rate risk in our trading activities was
immaterial.
Limitations of VaR Models
Although VaR models represent a recognized tool for risk management, they have inherent limitations, including
reliance on historical data that may not be indicative of future market conditions or trading patterns. Accordingly, you
should not view VaR models as a predictor of future results. We may incur losses that could be materially in excess of
the amounts indicated by the models on a particular trading day or over a period of time, and there have been instances
when results have fallen outside the values generated by our VaR models. A VaR model does not estimate the greatest
possible loss. We use these models together with other risk management tools, including stress testing. The results of
these models and analysis thereof are subject to the judgment of our risk management personnel.
Prudential Financial 2003 Annual Report 93