The VAR chart is useful in the sense that it describes values such as NPV a distribution as opposed to a single point estimate. No amount of modelling will ever fully anticipate what lady fortune has in store but it is still worth trying to gain a deeper understanding of risk drivers so you can make better decisions or create managerial options that help to exploit future uncertainty.
In the vein of trying to make the concept generally accessible to the uninitiated, busy executive we can add some useful refinements. The general shape of the chart itself conveys some information quickly e.g. if it is bimodal.
Personally I have these specific problems with the representation
A cumulative plot is not as intuitive as a probability density function – especially if the distribution is bimodal or more complex (in a cumulative plot people look at the flat region of constant probability and get confused, whereas when you see two humps in a pdf it is obvious that some values are not allowed)
When I want to extract numeric values (in a presentation when showing power point slides) it is quite tiresome to try and read off the chart axis every time; especially if it is interval data
Not everyone is familiar with likelihood or probability but odds on they’ll be familiar with the concept of odds.
Interactive VAR Chart – Click here to launch VAR chart
The output of a Monte Carlo model will be table of numbers describing the distribution. We can easily take these values and create an interactive VAR chart dashboard.
The user still gains the same insight from the overall shape
They can control a lower limit slider that allows them to look at the downside part of the distribution to answer questions such as “what are the odds we’ll lose money overall on this project”
A second slider allows them to get upside and interval information e.g. “what are the odds the NPV will be between $5m and $10m”.
Some of the newer Monte Carlo packages (Risk Solver at www.solver.com) allow you to generate these charts in near real time; however with Xcelcius I can embed this chart into power point and pdf documents and distribute the model.