A Decision Rule to Minimize Daily Capital Charges in Forecasting Value-at-Risk

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

No CIRJE-F-644, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

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 analyze the profit maximizing problem of an ADI subject to capital requirements under the Basel II Accord as ADI's have to choose an optimal VaR reporting strategy that minimizes daily capital charges. Accordingly, we suggest a dynamic communication and forecasting strategy 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.

Pages: 36 pages
Date: 2009-08
New Economics Papers: this item is included in nep-reg and nep-rmg
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Citations: View citations in EconPapers (49)

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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 (2008)
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