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Internal Model Validation in Brazil: Analysis of VaR Backtesting Methodologies

Alan Cosme Rodrigues da Silva (), Claudio Henrique da Silveira Barbedo (), Gustavo Araujo () and Myrian Beatriz Eiras das Neves ()
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Alan Cosme Rodrigues da Silva: Central Bank of Brazil
Claudio Henrique da Silveira Barbedo: Central Bank of Brazil
Myrian Beatriz Eiras das Neves: Central Bank of Brazil

Brazilian Review of Finance, 2006, vol. 4, issue 1, 97-118

Abstract: The purpose of this paper is to analyze backtesting methodologies of VaR, focusing on aspects as suitability to volatile markets and limited data set. We verify, from regulatory standpoint, tests to complement the Basel traffic light results, using simulated and real data. The results indicate that tests based on failures proportion are not adequate for small samples even fro 1,000 observations. The Basel criterion is conservative and has low power, which does not invalidate its application, as the criterion is only one of the procedures adopted in internal model validation process. Thus, it is suggested using tests that capture the shape of returns distribution, as the Kuiper test, in addition to the Basel criterion.

Keywords: Backtest; VaR tests; simulation; market risk (search for similar items in EconPapers)
JEL-codes: D81 E37 G21 (search for similar items in EconPapers)
Date: 2006
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