There is a VaR Beyond Usual Approximations

Marie Kratz ()
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Marie Kratz: ESSEC Business School, MAP5 - UMR 8145 - Mathématiques Appliquées Paris 5 - UPD5 - Université Paris Descartes - Paris 5 - INSMI-CNRS - Institut National des Sciences Mathématiques et de leurs Interactions - CNRS Mathématiques - CNRS - Centre National de la Recherche Scientifique

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Abstract: Basel II and Solvency 2 both use the Value-at Risk (VaR) as the risk measure to compute the Capital Requirements. In practice, to calibrate the VaR, a normal approximation is often chosen for the unknown distribution of the yearly log returns of financial assets. This is usually justified by the use of the Central Limit Theorem (CLT), when assuming aggregation of independent and identically distributed (iid) observations in the portfolio model. Such a choice of modeling, in particular using light tail distributions, has proven during the crisis of 2008/2009 to be an inadequate approximation when dealing with the presence of extreme returns; as a consequence, it leads to a gross underestimation of the risks. The main objective of our study is to obtain the most accurate evaluations of the aggregated risks distribution and risk measures when working on financial or insurance data under the presence of heavy tail and to provide practical solutions for accurately estimating high quantiles of aggregated risks. We explore a new method, called Normex, to handle this problem numerically as well as theoretically, based on properties of upper order statistics. Normex provides accurate results, only weakly dependent upon the sample size and the tail index. We compare it with existing methods.

Keywords: Stable Distribution; Conditional (Pareto) Distribution; Conditional (Pareto) Moment; Convolution; Expected Short Fall; Extreme Values; Rate of Convergence; Financial Data; Aggregated risk; (generalized) Central Limit Theorem; (refined) Berry-Esséen Inequality; Order Statistics; Value-at-Risk; Market Risk; Pareto Distribution; Risk Measures; High Frequency Data (search for similar items in EconPapers)
Date: 2013
Note: View the original document on HAL open archive server: https://essec.hal.science/hal-00880258
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Citations: View citations in EconPapers (6)

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