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Choosing expected shortfall over VaR in Basel III using stochastic dominance

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  • Chang, Chia-Lin
  • Jimenez-Martin, Juan-Angel
  • Maasoumi, Esfandiar
  • McAleer, Michael
  • Pérez-Amaral, Teodosio

Abstract

In this paper we use stochastic dominance to evaluate the consequences of moving from Value-at-Risk (VaR) to Expected Shortfall (ES) from a policy maker's perspective. In particular, we compare VaR at the 99% level (VaR99) and ES at the 97.5% level (ES97.5). We contemplate VaR99 and ES97.5 as two alternative risk metrics according to the capital adequacy bank regulation, as suggested by Basel III. Moving from VaR99 to ES97.5 will have effects in terms of the quantity and quality of the capital required to banks. According to the Basel Committee on Banking Supervision (2013, page 18):

Suggested Citation

  • Chang, Chia-Lin & Jimenez-Martin, Juan-Angel & Maasoumi, Esfandiar & McAleer, Michael & Pérez-Amaral, Teodosio, 2019. "Choosing expected shortfall over VaR in Basel III using stochastic dominance," International Review of Economics & Finance, Elsevier, vol. 60(C), pages 95-113.
  • Handle: RePEc:eee:reveco:v:60:y:2019:i:c:p:95-113
    DOI: 10.1016/j.iref.2018.12.016
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    Cited by:

    1. Stephan Eckstein & Michael Kupper & Mathias Pohl, 2018. "Robust risk aggregation with neural networks," Papers 1811.00304, arXiv.org, revised Jul 2019.
    2. Duc Hong Vo & Ngoc Phu Tran & Tam Nguyen-Thanh Duong & Michael McAleer, 2019. "Risk analysis of energy in Vietnam," Documentos de Trabajo del ICAE 2019-14, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    3. repec:gam:jrisks:v:6:y:2018:i:2:p:61-:d:150249 is not listed on IDEAS

    More about this item

    Keywords

    Stochastic dominance; Value-at-Risk; Expected shortfall; Basel III accord; Daily capital charges;

    JEL classification:

    • 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
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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