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Market risk, value-at-risk and exponential weighting

Author

Listed:
  • Broll Udo

    (Center of International Studies (ZIS), Faculty of Business and Economics, Technische Universität Dresden, Helmholtzstr. 10, 01062 Dresden, Germany)

  • Förster Andreas

    (Faculty of Business and Economics, Technische Universität Dresden, Helmholtzstr. 10, 01062 Dresden, Germany)

Abstract

Banks and financial intermediaries are exposed to market risk. The aim of the paper is to explore the implications of legal requirements on market risk valuation. The focus is on the calculation of the permissible weighting factor of the concept of value-at-risk (VaR). When measuring market risk, banks and financial intermediaries may deviate from equally weighting historical data in their value-at-risk calculation and instead use an exponential time series weighting. The use of exponential weighting in the value-at-risk calculation is very popular because it takes into account changes in market volatility (immediately) and can therefore quickly adapt to VaR. In less volatile market phases this leads to a reduction in VaR and thus to lower own funds’ requirements for banks and financial intermediaries. However, in the exponential weighting a high volatility in the past is quickly forgotten and the VaR can be underestimated. To prevent this banks and financial intermediaries are not completely free to choose a weighting (decay) factor. The exchange rate between Polish zloty and euro is used to estimate the value-at-risk as an example and exceptions to the general legal requirements are also discussed.

Suggested Citation

  • Broll Udo & Förster Andreas, 2022. "Market risk, value-at-risk and exponential weighting," Economics and Business Review, Sciendo, vol. 8(2), pages 80-91, July.
    • Handle: RePEc:vrs:ecobur:v:8:y:2022:i:2:p:80-91:n:6
    DOI: 10.18559/ebr.2022.2.5
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    References listed on IDEAS

    as
    1. Xavier Freixas & Jean-Charles Rochet, 2008. "Microeconomics of Banking, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062704, December.
    2. Udo Broll & Anna Sobiech & Jack E. Wahl, 2012. "Banking Firm, Equity and Value at Risk," Contemporary Economics, University of Economics and Human Sciences in Warsaw., vol. 6(4), December.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    banks; financial intermediaries; risk management; market risk; exponentially weighted moving average; weighting scheme; value-at-risk;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E - Macroeconomics and Monetary Economics
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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