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The Ten Commandments for Managing Value-at-Risk Under the Basel II Accord

Author

Listed:
  • Juan-Angel Jimenez-Martin

    (Universidad Complutense de Madrid, Dpto. de Fundamentos de Análisis Económico II)

  • Michael McAleer

    (Universidad Complutense de Madrid, Dpto. de Fundamentos de Análisis Económico II)

  • Teodosio Pérez-Amaral

    (Dpto. de Fundamentos de Análisis Económico II, Universidad Complutense)

Abstract

Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) are required to communicate their daily market risk estimates to the relevant national monetary authority at the beginning of each trading day, using one of a variety of Value-at-Risk (VaR) models to measure risk. The purpose of this paper is to provide a simple explanation and a set of prescriptions for managing VaR under the Basel II Accord. The commandments deal with understanding the Basel II colours, understanding the risk model before choosing, varying the choice of risk model, avoiding the green zone and being willing to violate, incurring large violations, stopping before the red zone, avoiding frequent violations, avoiding the estimation of large portfolios, aggregating portfolios into a single index, and interpreting commandments sensibly as guidelines.

Suggested Citation

  • Juan-Angel Jimenez-Martin & Michael McAleer & Teodosio Pérez-Amaral, 2009. "The Ten Commandments for Managing Value-at-Risk Under the Basel II Accord," Documentos de Trabajo del ICAE 2009-12, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    • Handle: RePEc:ucm:doicae:0912
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    References listed on IDEAS

    as
    1. Manabu Asai & Michael McAleer & Jun Yu, 2006. "Multivariate Stochastic Volatility," Microeconomics Working Papers 22058, East Asian Bureau of Economic Research.
    2. Manabu Asai & Michael McAleer & Jun Yu, 2006. "Multivariate Stochastic Volatility: A Review," Econometric Reviews, Taylor & Francis Journals, vol. 25(2-3), pages 145-175.
    3. Michael McAleer & Marcelo Medeiros, 2008. "Realized Volatility: A Review," Econometric Reviews, Taylor & Francis Journals, vol. 27(1-3), pages 10-45.
    4. Michael McAleer & Bernardo da Veiga, 2008. "Single-index and portfolio models for forecasting value-at-risk thresholds," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 27(3), pages 217-235.
    5. Michael McAleer & Les Oxley, 2002. "The Econometrics of Financial Time Series," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 237-243, July.
    6. Massimiliano Caporin & Michael McAleer, 2009. "Do We Really Need Both BEKK and DCC? A Tale of Two Covariance Models," CIRJE F-Series CIRJE-F-638, CIRJE, Faculty of Economics, University of Tokyo.
    7. Michael Mcaleer & Bernardo da Veiga, 2008. "Forecasting value-at-risk with a parsimonious portfolio spillover GARCH (PS-GARCH) model," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 27(1), pages 1-19.
    8. McAleer, M.J. & Jiménez-Martín, J.A. & Pérez-Amaral, T., 2008. "A decision rule to minimize daily capital charges in forecasting value-at-risk," Econometric Institute Research Papers EI 2008-34, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    9. Li, W K & Ling, Shiqing & McAleer, Michael, 2002. "Recent Theoretical Results for Time Series Models with GARCH Errors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 245-269, July.
    10. W. K. Li & Shiqing Ling & Michael McAleer, 2002. "Recent Theoretical Results for Time Series Models with GARCH Errors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 245-269, July.
    11. Michael McAleer, 2009. "The Ten Commandments For Optimizing Value‐At‐Risk And Daily Capital Charges," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 831-849, December.
    12. McAleer, Michael, 2005. "Automated Inference And Learning In Modeling Financial Volatility," Econometric Theory, Cambridge University Press, vol. 21(1), pages 232-261, February.
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    Cited by:

    1. McAleer, Michael & Jimenez-Martin, Juan-Angel & Perez-Amaral, Teodosio, 2013. "GFC-robust risk management strategies under the Basel Accord," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 97-111.
    2. Hammoudeh, Shawkat & Malik, Farooq & McAleer, Michael, 2011. "Risk management of precious metals," The Quarterly Review of Economics and Finance, Elsevier, vol. 51(4), pages 435-441.
    3. Casarin, Roberto & Chang, Chia-Lin & Jimenez-Martin, Juan-Angel & McAleer, Michael & Pérez-Amaral, Teodosio, 2013. "Risk management of risk under the Basel Accord: A Bayesian approach to forecasting Value-at-Risk of VIX futures," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 94(C), pages 183-204.
    4. Chia-Lin Chang & Juan-à ngel Jiménez-Martín & Michael McAleer & Teodosio Pérez-Amaral, 2011. "Risk Management of Risk under the Basel Accord: Forecasting Value-at-Risk of VIX Futures," KIER Working Papers 761, Kyoto University, Institute of Economic Research.
    5. McAleer, Michael & Jimenez-Martin, Juan-Angel & Perez-Amaral, Teodosio, 2013. "Has the Basel Accord improved risk management during the global financial crisis?," The North American Journal of Economics and Finance, Elsevier, vol. 26(C), pages 250-265.
    6. Michael McAleer & Juan‐Ángel Jiménez‐Martín & Teodosio Pérez‐Amaral, 2013. "International Evidence on GFC‐Robust Forecasts for Risk Management under the Basel Accord," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 32(3), pages 267-288, April.
    7. Jimenez-Martin, Juan-Angel & McAleer, Michael & Pérez-Amaral, Teodosio & Santos, Paulo Araújo, 2013. "GFC-robust risk management under the Basel Accord using extreme value methodologies," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 94(C), pages 223-237.
    8. Michael McAleer, 2009. "The Ten Commandments For Optimizing Value‐At‐Risk And Daily Capital Charges," Journal of Economic Surveys, Wiley Blackwell, vol. 23(5), pages 831-849, December.
    9. Simone Varotto, 2011. "Liquidity risk, credit risk, market risk and bank capital," International Journal of Managerial Finance, Emerald Group Publishing Limited, vol. 7(2), pages 134-152, April.
    10. Michael McAleer & Juan-Angel Jimenez-Martin & Teodosio Pérez-Amaral, 0000. "Has the Basel II Accord Encouraged Risk Management during the 2008-09 Financial Crisis?," Tinbergen Institute Discussion Papers 09-039/4, Tinbergen Institute.
    11. da Veiga, B. & Chan, F. & McAleer, M.J., 2009. "It Pays to Violate: How Effective are the Basel Accord Penalties?," Econometric Institute Research Papers EI 2009-39, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
    12. McAleer, Michael & Jimenez-Martin, Juan-Angel & Perez Amaral, Teodosio, 2009. "Optimal Risk Management Before, During and After the 2008-09 Financial Crisis," MPRA Paper 20975, University Library of Munich, Germany, revised 20 Sep 2009.
    13. Michael McAleer & Juan-Angel Jimenez-Martin & Teodosio Perez-Amaral, 2009. "What Happened to Risk Management During the 2008-09 Financial Crisis?," CARF F-Series CARF-F-155, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
    14. Antonio Cabrales & Haydée Lugo, 2011. "An impure public good model with lotteries in large grou," Documentos de Trabajo del ICAE 2011-05, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
    15. Hammoudeh, Shawkat & Araújo Santos, Paulo & Al-Hassan, Abdullah, 2013. "Downside risk management and VaR-based optimal portfolios for precious metals, oil and stocks," The North American Journal of Economics and Finance, Elsevier, vol. 25(C), pages 318-334.
    16. Massoud Moslehpour & Shin Hung Pan & Aviral Kumar Tiwari & Wing Keung Wong, 2021. "Editorial in Honour of Professor Michael McAleer," Advances in Decision Sciences, Asia University, Taiwan, vol. 25(4), pages 1-14, December.

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    More about this item

    Keywords

    Financial portfolios; daily capital charges; frequency of violations; magnitude of violations; optimizing strategy; risk forecasts; value-at-risk; green zone; red zone.;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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