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

Roberta Fiori () and Simonetta Iannotti ()
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Roberta Fiori: Banca d'Italia
Simonetta Iannotti: Banca d'Italia

No 602, Temi di discussione (Economic working papers) from Bank of Italy, Economic Research and International Relations Area

Abstract: 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.

Keywords: Interest rate risk; VAR; PCA; Non-normality; Non parametric methods (search for similar items in EconPapers)
JEL-codes: C14 C19 G21 (search for similar items in EconPapers)
Date: 2006-09
New Economics Papers: this item is included in nep-ban, nep-ecm, nep-fin, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:bdi:wptemi:td_602_06

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