A decision rule to minimize daily capital charges in forecasting value-at-risk

Michael McAleer, Juan Jimenez-Martin and Teodosio Pérez-Amaral

No EI 2008-34, Econometric Institute Research Papers from Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute

Abstract: Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) have to communicate their daily risk estimates to the monetary authorities at the beginning of the trading day, using a variety of Value-at-Risk (VaR) models to measure risk. Sometimes the risk estimates communicated using these models are too high, thereby leading to large capital requirements and high capital costs. At other times, the risk estimates are too low, leading to excessive violations, so that realised losses are above the estimated risk. In this paper we propose a learning strategy that complements existing methods for calculating VaR and lowers daily capital requirements, while restricting the number of endogenous violations within the Basel II Accord penalty limits. We suggest a decision rule that responds to violations in a discrete and instantaneous manner, while adapting more slowly in periods of no violations. We apply the proposed strategy to Standard & Poor’s 500 Index and show there can be substantial savings in daily capital charges, while restricting the number of violations to within the Basel II penalty limits.

Keywords: daily capital charges; endogenous violations; frequency of violations; optimizing strategy; risk forecasts; value-at-risk (search for similar items in EconPapers)
JEL-codes: C53 G11 G17 G32 (search for similar items in EconPapers)
Date: 2008-12-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Working Paper: A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk (2009)
Working Paper: A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk (2009)
Working Paper: A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk (2009)
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