An EVT Approach to calculating Risk Capital Requirements
AbstractThis paper investigates the frequency of extreme events for three LIFFE futures contracts for the calculation of minimum capital risk requirements (MCRRs). We propose a semi-parametric approach where the tails are modelled by the Generalised Pareto Distribution and smaller risks are captured by the empirical distribution function. We compare the capital requirements from this approach with those calculated from the unconditional density and from a conditional density- a GARCH(1,1) model. Our primary finding is that for both in-sample and hold-out samples, our extreme value approach yields superior results than either of the other two models which do not explicitly model the tails of the return distribution. Since the use of these internal models will be permitted under the EC-CAD II, they could be widely adopted in the near future by European financial institutions for determining capital adequacies. Hence, close scrutiny of competing models is required to avoid a potentially costly misallocation of capital resources while at the same time ensuring the safety of the financial system.
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Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2000-07.
Length: 25 pages
Date of creation: Jul 2000
Date of revision:
Publication status: Published in Journal of Risk Finance 2002, 3:2, 22 – 33.
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More information through EDIRC
Minimum Capital Risk Requirments; Generalised Pareto Distribution; GARCH models;
Find related papers by JEL classification:
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
- C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Hsieh, David A., 1993. "Implications of Nonlinear Dynamics for Financial Risk Management," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(01), pages 41-64, March.
- Brooks, C. & Clare, A. D. & Persand, G., 2000. "A word of caution on calculating market-based minimum capital risk requirements," Journal of Banking & Finance, Elsevier, vol. 24(10), pages 1557-1574, October.
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- repec:att:wimass:9520 is not listed on IDEAS
- Jon DANIELSSON & Casper G. DE VRIES, 2000.
"Value-at-Risk and Extreme Returns,"
Annales d'Economie et de Statistique,
ENSAE, issue 60, pages 239-270.
- Longin, Francois M, 1996. "The Asymptotic Distribution of Extreme Stock Market Returns," The Journal of Business, University of Chicago Press, vol. 69(3), pages 383-408, July.
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