IDEAS home Printed from https://ideas.repec.org/a/fip/fedfer/y1999p3-17n2.html
   My bibliography  Save this article

Methods for evaluating value-at-risk estimates

Author

Listed:
  • Jose A. Lopez

Abstract

Since 1998, U.S. commercial banks with significant trading activities have been required to hold capital against their defined market risk exposure. Under the "internal models" approach embodied in the current regulatory guidelines, the capital charges are a function of banks' own value-at-risk (VaR) estimates. VaR estimates are simply forecasts of the maximum portfolio loss that could occur over a given holding period with a specified confidence level. Clearly, the accuracy of these VaR estimates is of concern to both banks and their regulators. ; To date, two hypothesis-testing methods for evaluating VaR estimates have been proposed, namely, the binomial and the interval forecast methods. For these tests, the null hypothesis is that the VaR estimates in question exhibit a specified property that is characteristic of accurate VaR estimates. As shown in a simulation exercise, these tests generally have low power and are thus prone to misclassifying inaccurate VaR estimates as "acceptably accurate." ; An alternative evaluation method, based on regulatory loss functions, is proposed. Magnitude loss functions that assign quadratic numerical scores when observed portfolio losses exceed VaR estimates are shown to be particularly useful. Simulation results indicate that the loss function evaluation method is capable of distinguishing between VaR estimates generated by accurate and alternative VaR models. The additional information provided by this method as well as its flexibility with respect to the specification of the loss function make a reasonable case for its use in the regulatory evaluation of VaR estimates.

Suggested Citation

  • Jose A. Lopez, 1999. "Methods for evaluating value-at-risk estimates," Economic Review, Federal Reserve Bank of San Francisco, pages 3-17.
  • Handle: RePEc:fip:fedfer:y:1999:p:3-17:n:2
    as

    Download full text from publisher

    File URL: http://www.frbsf.org/econrsrch/econrev/99-2/3-17.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Francis X. Diebold & Todd A. Gunther & Anthony S. Tay, "undated". "Evaluating Density Forecasts," CARESS Working Papres 97-18, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
    2. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 39-69.
    3. Paul H. Kupiec & James M. O'Brien, 1995. "A pre-commitment approach to capital requirements for market risk," Proceedings 475, Federal Reserve Bank of Chicago.
    4. 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.).
    5. Granger, C.W.J. & Pesaran, H., 1996. "A Decision_Theoretic Approach to Forecast Evaluation," Cambridge Working Papers in Economics 9618, Faculty of Economics, University of Cambridge.
    6. Jose A. Lopez, 1996. "Regulatory Evaluation of Value-at-Risk Models," Center for Financial Institutions Working Papers 96-51, Wharton School Center for Financial Institutions, University of Pennsylvania.
    7. Matthew Pritsker, 1997. "Evaluating Value at Risk Methodologies: Accuracy versus Computational Time," Journal of Financial Services Research, Springer;Western Finance Association, vol. 12(2), pages 201-242, October.
    8. Francis X. Diebold & Jose A. Lopez, 1995. "Forecast evaluation and combination," Research Paper 9525, Federal Reserve Bank of New York.
    9. Darryll Hendricks & Beverly Hirtle, 1997. "Bank capital requirements for market risk: the internal models approach," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 1-12.
    10. Jose A. Lopez, 1999. "Methods for evaluating value-at-risk estimates," Economic Review, Federal Reserve Bank of San Francisco, pages 3-17.
    11. Diebold, Francis X & Gunther, Todd A & Tay, Anthony S, 1998. "Evaluating Density Forecasts with Applications to Financial Risk Management," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 863-883, November.
    12. Jeremy Berkowitz, 1999. "Evaluating the forecasts of risk models," Finance and Economics Discussion Series 1999-11, Board of Governors of the Federal Reserve System (U.S.).
    13. Christoffersen, Peter F, 1998. "Evaluating Interval Forecasts," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 841-862, November.
    14. Phillip Kearns & Adrian Pagan, 1997. "Estimating The Density Tail Index For Financial Time Series," The Review of Economics and Statistics, MIT Press, vol. 79(2), pages 171-175, May.
    15. Matthew Pritsker, 1996. "Evaluating Value-at-Risk Methodologies: Accuracy versus Computational Time," Center for Financial Institutions Working Papers 96-48, Wharton School Center for Financial Institutions, University of Pennsylvania.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Risk ; Bank stocks;

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedfer:y:1999:p:3-17:n:2. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Federal Reserve Bank of San Francisco Research Library). General contact details of provider: http://edirc.repec.org/data/frbsfus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.