A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk
AbstractUnder the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) have to communicate their daily risk estimates to the monetary authorities at the beginning of the trading day, using a variety of Value-at-Risk (VaR) models to measure risk. Sometimes the risk estimates communicated using these models are too high, thereby leading to large capital requirements and high capital costs. At other times, the risk estimates are too low, leading to excessive violations, so that realised losses are above the estimated risk. In this paper we propose a learning strategy that complements existing methods for calculating VaR and lowers daily capital requirements, while restricting the number of endogenous violations within the Basel II Accord penalty limits. We suggest a decision rule that responds to violations in a discrete and instantaneous manner, while adapting more slowly in periods of no violations. We apply the proposed strategy to Standard & Poor’s 500 Index and show there can be substantial savings in daily capital charges, while restricting the number of violations to within the Basel II penalty limits.
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Bibliographic InfoPaper provided by Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales in its series Documentos del Instituto Complutense de Análisis Económico with number 0907.
Length: 29 pages
Date of creation: 2009
Date of revision:
Daily capital charges; endogenous violations; frequency of violations; optimizing strategy; risk forecasts; value-at-risk.;
Other versions of this item:
- Michael McAleer & Juan-Angel Jimenez-Martin & Teodosio Perez-Amaral, 2009. "A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk," CIRJE F-Series CIRJE-F-644, CIRJE, Faculty of Economics, University of Tokyo.
- Michael McAleer & Juan-Angel Jimenez-Martin & Teodosio Perez-Amaral, 2009. "A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk," CARF F-Series CARF-F-159, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
- McAleer, M.J. & Jimenez-Martin, J-A. & Perez-Amaral, T., 2008. "A decision rule to minimize daily capital charges in forecasting value-at-risk," Econometric Institute Report EI 2008-34, Erasmus University Rotterdam, Econometric Institute.
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-03-22 (All new papers)
- NEP-FMK-2009-03-22 (Financial Markets)
- NEP-REG-2009-03-22 (Regulation)
- NEP-RMG-2009-03-22 (Risk Management)
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