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Stress Tests of Capital Requirements

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  • Elroy Dimson
  • Paul Marsh

Abstract

This paper examines the performance of the leading methods for setting capital requirements for securities firms' trading books. Tests are conducted on a large sample of UK equity market makers' books over a substantial number of periods of equity market stress from 1985 to 1995. The comprehensive and building-block approaches, favoured by US and European regulators, fail to provide effective cover. Only portfolio-based, value-at-risk type models are efficient in providing appropriate levels of capital to cover the position risk of equity trading books. This paper was presented at the Financial Institutions Center's October 1996 conference on "

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File URL: http://fic.wharton.upenn.edu/fic/papers/96/9650.pdf
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Bibliographic Info

Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 96-50.

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Date of creation: Oct 1996
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Handle: RePEc:wop:pennin:96-50

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References

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  1. M.J.B. Hall, 1996. "The amendment to the capital accord to incorporate market risk," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 49(197), pages 271-277.
  2. William F. Sharpe, 1963. "A Simplified Model for Portfolio Analysis," Management Science, INFORMS, vol. 9(2), pages 277-293, January.
  3. Brenner, Menachem, 1979. "The Sensitivity of the Efficient Market Hypothesis to Alternative Specifications of the Market Model," Journal of Finance, American Finance Association, vol. 34(4), pages 915-29, September.
  4. Allen N. Berger & Richard J. Herring & Giorgio P. Szego, 1995. "The role of capital in financial institutions," Finance and Economics Discussion Series 95-23, Board of Governors of the Federal Reserve System (U.S.).
  5. Elroy Dimson and Paul Marsh., 1981. "The Stability of UK Risk Measures and the Problem of Thin Trading," Research Program in Finance Working Papers 120, University of California at Berkeley.
  6. Pyle, David H., 1986. "Capital regulation and deposit insurance," Journal of Banking & Finance, Elsevier, vol. 10(2), pages 189-201, June.
  7. Miller, Merton H., 1996. "The social costs of some recent derivatives disasters," Pacific-Basin Finance Journal, Elsevier, vol. 4(2-3), pages 113-127, July.
  8. Michael Phelan, 1995. "Probability and Statistics Applied to the Practice of Financial Risk Management: The Case of JP Morgan's RiskMetrics™," Center for Financial Institutions Working Papers 95-19, Wharton School Center for Financial Institutions, University of Pennsylvania.
  9. Charles Bralver & Andrew Kuritzkes, 1993. "Risk Adjusted Performance Measurement In The Trading Room," Journal of Applied Corporate Finance, Morgan Stanley, vol. 6(3), pages 104-108.
  10. Landskroner, Yoram & Paroush, Jacob, 1994. "Deposit insurance pricing and social welfare," Journal of Banking & Finance, Elsevier, vol. 18(3), pages 531-552, May.
  11. Robert C. Merton, 1995. "Financial Innovation and the Management and Regulation of Financial Institutions," NBER Working Papers 5096, National Bureau of Economic Research, Inc.
  12. Dale, R. & Wolfe, S., 1996. "EU Capital Requirements and the Level Playing Field," Papers 96-111, University of Southampton - Department of Accounting and Management Science.
  13. Paul H. Kupiec, 1995. "Techniques for verifying the accuracy of risk measurement models," Finance and Economics Discussion Series 95-24, Board of Governors of the Federal Reserve System (U.S.).
  14. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
  15. Brown, Stephen J. & Warner, Jerold B., 1985. "Using daily stock returns : The case of event studies," Journal of Financial Economics, Elsevier, vol. 14(1), pages 3-31, March.
  16. Robert C. Merton & André Perold, 1993. "Theory Of Risk Capital In Financial Firms," Journal of Applied Corporate Finance, Morgan Stanley, vol. 6(3), pages 16-32.
  17. Brown, Stephen J. & Warner, Jerold B., 1980. "Measuring security price performance," Journal of Financial Economics, Elsevier, vol. 8(3), pages 205-258, September.
  18. Dimson, Elroy & Marsh, Paul, 1995. " Capital Requirements for Securities Firms," Journal of Finance, American Finance Association, vol. 50(3), pages 821-51, July.
  19. Christopher L. Culp & Merton H. Miller, 1995. "Metallgesellschaft And The Economics Of Synthetic Storage," Journal of Applied Corporate Finance, Morgan Stanley, vol. 7(4), pages 62-76.
  20. Paul H. Kupiec & James M. O'Brien, 1995. "A pre-commitment approach to capital requirements for market risk," Finance and Economics Discussion Series 95-36, Board of Governors of the Federal Reserve System (U.S.).
  21. M.J.B. Hall, 1996. "The amendment to the capital accord to incorporate market risk," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 49(197), pages 271-277.
  22. Dimson, Elroy & Marsh, Paul, 1990. "Volatility forecasting without data-snooping," Journal of Banking & Finance, Elsevier, vol. 14(2-3), pages 399-421, August.
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Cited by:
  1. John Cotter, 2004. "Realized volatility and minimum capital requirements," Money Macro and Finance (MMF) Research Group Conference 2003 20, Money Macro and Finance Research Group.
  2. Paul Louis Ceriel Hilbers & Alfredo Mario Leone & Mahinder Singh Gill & Owen Evens, 2000. "Macroprudential Indicators of Financial System Soundness," IMF Occasional Papers 192, International Monetary Fund.
  3. Longin, Francois M., 2000. "From value at risk to stress testing: The extreme value approach," Journal of Banking & Finance, Elsevier, vol. 24(7), pages 1097-1130, July.
  4. Cabedo Semper, J. David & Moya Clemente, Ismael, 2003. "Value at risk calculation through ARCH factor methodology: Proposal and comparative analysis," European Journal of Operational Research, Elsevier, vol. 150(3), pages 516-528, November.
  5. John Cotter, 2011. "Minimum Capital Requirement Calculations for UK Futures," Working Papers 200418, Geary Institute, University College Dublin.
  6. Longin, François, 1999. "From Value at Risk to Stress Testing: The Extreme Value Approach," CEPR Discussion Papers 2161, C.E.P.R. Discussion Papers.
  7. Basu, Sanjay, 2011. "Comparing simulation models for market risk stress testing," European Journal of Operational Research, Elsevier, vol. 213(1), pages 329-339, August.
  8. 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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