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Scenario Based Principal Component Value-at-Risk: an Application to Italian Banks' Interest Rate Risk Exposure

  • Roberta Fiori

    ()

    (Banca d'Italia)

  • Simonetta Iannotti

    ()

    (Banca d'Italia)

Registered author(s):

    The paper develops a Value-at-Risk methodology to assess Italian banks� interest rate risk exposure. By using 5 years of daily data, the exposure is evaluated through a Principal Component VaR based on Monte Carlo simulation according to two different approaches (parametric and non-parametric). The main contribution of the paper is a methodology for modelling interest rate changes when underlying risk factors are skewed and heavy-tailed. The methodology is then implemented on a one year holding period in order to compare the results from those resulting from the Basel II standardized approach. We find that the risk measure proposed by Basel II gives an adequate description of risk, provided that duration parameters are changed to reflect market conditions. Finally, the methodology is used to perform a stress testing analysis.

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    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2006/2006-0602/tema_602.pdf
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    Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 602.

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    Date of creation: Sep 2006
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    Handle: RePEc:bdi:wptemi:td_602_06
    Contact details of provider: Postal: Via Nazionale, 91 - 00184 Roma
    Web page: http://www.bancaditalia.it

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    1. Papke, Leslie E & Wooldridge, Jeffrey M, 1996. "Econometric Methods for Fractional Response Variables with an Application to 401(K) Plan Participation Rates," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(6), pages 619-32, Nov.-Dec..
    2. Vlaar, Peter J. G., 2000. "Value at risk models for Dutch bond portfolios," Journal of Banking & Finance, Elsevier, vol. 24(7), pages 1131-1154, July.
    3. Peter Christoffersen & Jinyong Hahn & Atsushi Inoue, 2001. "Testing and Comparing Value-at-Risk Measures," CIRANO Working Papers 2001s-03, CIRANO.
    4. Farshid Jamshidian & Yu Zhu, 1996. "Scenario Simulation: Theory and methodology (*)," Finance and Stochastics, Springer, vol. 1(1), pages 43-67.
    5. R. Brummelhuis & A. Cãrdoba & M. Quintanilla & L. Seco, 2002. "Principal Component Value at Risk," Mathematical Finance, Wiley Blackwell, vol. 12(1), pages 23-43.
    6. Marida Bertocchi & Rosella Giacometti & Stavros A. Zenios, 2000. "Risk Factor Analysis and Portfolio Immunization in the Corporate Bond Market," Center for Financial Institutions Working Papers 00-40, Wharton School Center for Financial Institutions, University of Pennsylvania.
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