Scenario Based Principal Component Value-at-Risk: an Application to Italian Banks' Interest Rate Risk Exposure
AbstractThe paper develops a Value-at-Risk methodology to assess Italian banksÂ’ interest rate risk exposure. By using 5 years of daily data, the exposure is evaluated through a Principal Component VaR based on Monte Carlo simulation according to two different approaches (parametric and non-parametric). The main contribution of the paper is a methodology for modelling interest rate changes when underlying risk factors are skewed and heavy-tailed. The methodology is then implemented on a one year holding period in order to compare the results from those resulting from the Basel II standardized approach. We find that the risk measure proposed by Basel II gives an adequate description of risk, provided that duration parameters are changed to reflect market conditions. Finally, the methodology is used to perform a stress testing analysis.
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Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 602.
Date of creation: Sep 2006
Date of revision:
Interest rate risk; VAR; PCA; Non-normality; Non parametric methods;
Find related papers by JEL classification:
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C19 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Other
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-10-07 (All new papers)
- NEP-BAN-2006-10-07 (Banking)
- NEP-ECM-2006-10-07 (Econometrics)
- NEP-FMK-2006-10-07 (Financial Markets)
- NEP-RMG-2006-10-07 (Risk Management)
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