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The impact of the choice of VaR models on the level of regulatory capital according to Basel II

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  • Oliver Hermsen

Abstract

The Basel II framework allows the calculation of the capital requirements for market risk with Value-at-Risk models. Since no special model is prescribed in the framework, banks may use simple models with questionable assumptions concerning their underlying distributions. Our numerical analysis reveals that simple VaR models that perform noticeably worse than comparable simple models with more realistic assumptions may lead to a lower level of regulatory capital for banks. For this reason, banks have a major incentive to implement bad models. This is obviously contrary to the interests of regulatory authorities.

Suggested Citation

  • Oliver Hermsen, 2010. "The impact of the choice of VaR models on the level of regulatory capital according to Basel II," Quantitative Finance, Taylor & Francis Journals, vol. 10(10), pages 1215-1224.
    • Handle: RePEc:taf:quantf:v:10:y:2010:i:10:p:1215-1224
    DOI: 10.1080/14697680903419701
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    Citations

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    Cited by:

    1. Philip Maymin & Zakhar Maymin, 2012. "Any regulation of risk increases risk," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(3), pages 299-313, September.
    2. Orla Mccullagh & Mark Cummins & Sheila Killian, 2023. "The Fundamental Review of the Trading Book: Implications for Portfolio and Risk Management in the Banking Sector," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 55(7), pages 1785-1816, October.
    3. Orla McCullagh & Mark Cummins & Sheila Killian, 2023. "Decoupling VaR and regulatory capital: an examination of practitioners’ experience of market risk regulation," Journal of Banking Regulation, Palgrave Macmillan, vol. 24(3), pages 321-336, September.

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