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The Cost of Conservatism: Extreme Returns, Value-at Risk, and the Basle Multiplicaiton Factor

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  • Philipp Hartmann
  • Jon Danielsson

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Abstract

We argue that most current methodologies for value-at-risk (VaR) underestimate the VaR, and are therefore ill-suited for market risk capital. Better VaR methods are available, such as the tail-fitting method proposed here. However, financial institutions may be relctant to use those mehtods since current market risk regulations may, perversely, provide incentives for banks to underestimate the VaR.

Suggested Citation

  • Philipp Hartmann & Jon Danielsson, 1998. "The Cost of Conservatism: Extreme Returns, Value-at Risk, and the Basle Multiplicaiton Factor," FMG Special Papers sp100, Financial Markets Group.
  • Handle: RePEc:fmg:fmgsps:sp100
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    File URL: http://www.lse.ac.uk/fmg/documents/specialPapers/1990s/sp100.pdf
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    References listed on IDEAS

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    1. Paul H. Kupiec & James M. O'Brien, 1997. "The pre-commitment approach: using incentives to set market risk capital requirements," Finance and Economics Discussion Series 1997-14, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:

    1. Jon Danielsson & Casper De Vries & Bjorn N. Jorgensen, 1998. "The value of value at risk: statistical, financial, and regulatory considerations (summary)," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 107-108.
    2. Rossignolo, Adrián F. & Fethi, Meryem Duygun & Shaban, Mohamed, 2013. "Market crises and Basel capital requirements: Could Basel III have been different? Evidence from Portugal, Ireland, Greece and Spain (PIGS)," Journal of Banking & Finance, Elsevier, vol. 37(5), pages 1323-1339.
    3. Wagner Piazza Gaglianone & Luiz Renato Lima & Oliver Linton & Daniel R. Smith, 2011. "Evaluating Value-at-Risk Models via Quantile Regression," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 29(1), pages 150-160, January.
    4. Giacomo Bormetti & Maria Elena De Giuli & Danilo Delpini & Claudia Tarantola, 2008. "Bayesian Analysis of Value-at-Risk with Product Partition Models," Papers 0809.0241, arXiv.org, revised May 2009.
    5. Adam Misiorek & Rafal Weron, 2010. "Heavy-tailed distributions in VaR calculations," HSC Research Reports HSC/10/05, Hugo Steinhaus Center, Wroclaw University of Technology.
    6. Szymon Borak & Adam Misiorek & Rafał Weron, 2010. "Models for Heavy-tailed Asset Returns," SFB 649 Discussion Papers SFB649DP2010-049, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    7. Rossignolo, Adrian F. & Fethi, Meryem Duygun & Shaban, Mohamed, 2012. "Value-at-Risk models and Basel capital charges," Journal of Financial Stability, Elsevier, vol. 8(4), pages 303-319.
    8. Gimeno, Ricardo & Gonzalez, Clara I., 2012. "An automatic procedure for the estimation of the tail index," MPRA Paper 37023, University Library of Munich, Germany.
    9. Flavio Bazzana, 2001. "I modelli interni per la valutazione del rischio di mercato secondo l'approccio del Value at Risk," Alea Tech Reports 011, Department of Computer and Management Sciences, University of Trento, Italy, revised 14 Jun 2008.
    10. Weron, Rafał, 2004. "Computationally intensive Value at Risk calculations," Papers 2004,32, Humboldt University of Berlin, Center for Applied Statistics and Economics (CASE).

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