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Value-at-Risk models and Basel capital charges

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  • Rossignolo, Adrian F.
  • Fethi, Meryem Duygun
  • Shaban, Mohamed

Abstract

In the wake of the subprime crisis of 2007 which uncovered shortfalls in capital levels of most financial institutions, the Basel Committee planned to strengthen current regulations contained in Basel II. While maintaining the Internal Model Approach based on Value-at-Risk, a stressed VaR calculated over highly strung periods is to be added to present directives to constitute Minimum Capital Requirements. Consequently, the adoption of the appropriate VaR specification remains a subject of paramount importance as it determines the financial condition of the firm. In this article I explore the performance of several models to compute MCR in the context of Emerging and Frontier stock markets within the present and proposed capital structures. Considering the evidence gathered, two major contributions arise: (a) heavy-tailed distributions – particularly Extreme Value (EV) ones-, reveal as the most accurate technique to model market risks, hence preventing huge capital deficits under current measures; (b) the application of such methods could allow slight modifications to present mandate and simultaneously avoid sVaR or at least reduce its scope, thus mitigating the impact regarding the enhancement of capital base. Therefore, I suggest that the inclusion of EV in planned supervisory accords should reduce development costs and foster healthier financial structures.

Suggested Citation

  • Rossignolo, Adrian F. & Fethi, Meryem Duygun & Shaban, Mohamed, 2012. "Value-at-Risk models and Basel capital charges," Journal of Financial Stability, Elsevier, vol. 8(4), pages 303-319.
    • Handle: RePEc:eee:finsta:v:8:y:2012:i:4:p:303-319
    DOI: 10.1016/j.jfs.2011.11.003
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    More about this item

    Keywords

    Value-at-Risk; Extreme Value Theory; Emerging and Frontier markets; Capital Requirements; Stressed VaR;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables

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