Model risk and capital reserves

Jeroen Kerkhof, Bertrand Melenberg and Johannes Schumacher

Journal of Banking & Finance, 2010, vol. 34, issue 1, 267-279

Abstract: We propose a procedure to take model risk into account in the computation of capital reserves. This addresses the need to make the allocation of capital reserves to positions in given markets dependent on the extent to which reliable models are available. The proposed procedure can be used in combination with any of the standard risk measures, such as Value-at-Risk and expected shortfall. We assume that models are obtained by usual econometric methods, which allows us to distinguish between estimation risk and misspecification risk. We discuss an additional source of risk which we refer to as identification risk. By way of illustration, we carry out calculations for equity and FX data sets. In both markets, estimation risk and misspecification risk together explain about half of the multiplication factors employed by the Bank for International Settlements (BIS).

Keywords: Capital; requirements; Model; risk; Risk; measures; Estimation; risk; Misspecification; risk; Identification; risk (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (64)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:34:y:2010:i:1:p:267-279

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