Measuring market risk using extreme value theory

Dennis Mapa () and Oliver Q. Suaiso

MPRA Paper from University Library of Munich, Germany

Abstract: The adoption of Basel II standards by the Bangko Sentral ng Pilipinas initiates financial institutions to develop value-at-risk (VaR) models to measure market risk. In this paper, two VaR models are considered using the peaks-over-threshold (POT) approach of the extreme value theory: (1) static EVT model which is the straightforward application of POT to the bond benchmark rates; and (2) dynamic EVT model which applies POT to the residuals of the fitted AR-GARCH model. The results are compared with traditional VaR methods such as RiskMetrics and AR-GARCH-type models. The relative size, accuracy and efficiency of the models are assessed using mean relative bias, backtesting, likelihood ratio tests, loss function, mean relative scaled bias and computation of market risk charge. Findings show that the dynamic EVT model can capture market risk conservatively, accurately and efficiently. It is also practical to use because it has the potential to lower a bank’s capital requirements. Comparing the two EVT models, the dynamic model is better than static as the former can address some issues in risk measurement and effectively capture market risks.

Keywords: extreme value theory; peaks-over-threshold; value-at-risk; market risk; risk management (search for similar items in EconPapers)
JEL-codes: C01 C22 G12 (search for similar items in EconPapers)
Date: 2009-12
New Economics Papers: this item is included in nep-ban, nep-bec and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Journal Article: Measuring market risk using extreme value theory (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:21246

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