Use of stress scenarios in market risk economic capital
Abstract
Stress testing is increasingly being used to complement model-based estimates of risk, while stress value at risk (VaR) has been introduced to the regulatory framework for market risk capital. Stress tests, by their nature, are somewhat ad hoc and difficult to integrate with statistical measures of risk, such as VaR. This paper describes a method to combine in a consistent way stress losses with the output of the VaR model, in order to build an economic capital model for market risk. The method is based on existing components of firms' risk management systems, making it easy to implement, yet still exhibits many of the features (fat tails, tail correlations) missed by a simple model-based approach. The performance of the proposed model is examined during two market crises and it is shown that it outperforms both a purely statistical model and a purely stress test-based approach.
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Author's Biography
Alan Smillie is Head of Capital and Rating Methodology at Nomura, responsible for credit rating and economic capital globally. Prior to joining Nomura, Alan worked on market risk, counterparty credit risk and economic capital methodology at Citigroup. Alan holds a PhD in Quantitative Finance from Imperial College, London.
Eduardo Epperlein has 19 years’ experience in the financial industry and is currently Global Head of Risk Methodology at Nomura, responsible for credit, market and operational risk for both regulatory and economic capital, as well as stress testing. Prior to joining Nomura, Eduardo held various roles in risk methodology at Citigroup, including model validation. Eduardo holds a PhD in Plasma Physics from Imperial College, London.
Triyog Pandya is the member of Capital and Rating Methodology at Nomura responsible for the economic capital methodology for the firm. Prior to Joining Nomura, Triyog worked on market risk at Yes Bank in India and KPMG Risk consultancy. Triyog has a total of 7 years of risk experience. He holds a Chartered Accountant’s degree from Institute of Chartered Accountants of India and is currently a student member of Institute of Actuaries of India.
Citation
Smillie, Alan, Epperlein, Eduardo and Pandya, Triyog (2013, December 1). Use of stress scenarios in market risk economic capital. In the Journal of Risk Management in Financial Institutions, Volume 7, Issue 1. https://doi.org/10.69554/PHJV4940.
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