Portfolios evolve over time. There is a natural evolution of the portfolio due to events
such as coupon and principal payments and the expiration and settlement of forward
and option contracts. To accurately characterize the economic value of a portfolio at
the target date, it is necessary to track cashflows that are received between the
anchor and target dates and to make some reasonable assumptions as to how these
received cashflows are reinvested.
Probably the most expedient approach to dealing with the effects of received
cashflows is to incorporate a reinvestment assumption into the VaR methodology.
There are two obvious choices; a cashflow is reinvested in a cash account at the riskfree
short rate or the coupon is reinvested in a zero-coupon bond maturing at time
T, with the former choice being more natural since it is independent of the time
horizon. If we make the latter choice, we need to know the term structure at time tp;
if we make the former choice, we need to know the short rate over the interval [tp, T ].
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