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How to choose the return model for market risk? Getting towards a right magnitude of stressed VaR

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  • Mark Lichtner

Abstract

Value at Risk (VaR) and stressed value at Risk (SVaR) or expected shortfall are important risk measures widely used in the financial services industry for risk management and market risk capital computation. Fundamental to any (S)VaR model is the choice of the return type model for each risk factor. Because the resulting SVaR numbers are highly sensitive to the chosen return type model it is important to make a prudent choice on the return type modelling. We propose to estimate the return type model from historic data without making an a priori model assumption on the return model. We explain the fundamentals of return type modelling and how it impacts the magnitude of SVaR. We further show how to obtain a global return type model from a set of similar return type models by using geometric calculus. Numerical simulations and illustrations are provided. In this paper, we consider interest rate data, but the proposed methodology is general and can be applied to any other asset class such as inflation, credit spread, equity or fx.

Suggested Citation

  • Mark Lichtner, 2019. "How to choose the return model for market risk? Getting towards a right magnitude of stressed VaR," Quantitative Finance, Taylor & Francis Journals, vol. 19(8), pages 1391-1407, August.
    • Handle: RePEc:taf:quantf:v:19:y:2019:i:8:p:1391-1407
    DOI: 10.1080/14697688.2019.1579924
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    Cited by:

    1. Michele Leonardo Bianchi, 2023. "Assessing and forecasting the market risk of bank securities holdings: a data-driven approach," Risk Management, Palgrave Macmillan, vol. 25(4), pages 1-23, December.

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