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Practice paper

Evaluation of the Basel VaR-based market risk charge and proposals for a needed adjustment

Jens Fricke and Ralf Pauly
Journal of Risk Management in Financial Institutions, 5 (4), 398-420 (2012)
https://doi.org/10.69554/XSWC5125

Abstract

This analysis shows that in high risk situations the Basel II guidelines fail in the attempt to cushion against large losses by higher capital requirements. One of the factors causing this problem is that the built-in positive incentive of the penalty factor resulting from the Basel backtesting is set too weak. Therefore, this paper proposes a new procedure for market risk regulation and it demonstrates how this works with real time series. A comparison study shows that contrary to the existing Basel regulation the proposition presented here has the intended quality as a built-in incentive for choosing a reliable forecasting model. By including the expected shortfall as a further measure of risk this paper's concept yields a steeper increase of the penalty factor and as a consequence a stronger effect of risk underestimation on the capital requirement. The recent proposal of the Basel Committee on Banking Supervision may have the same weakness as the Basel II regulation because it is constructed in an analogous manner.

Keywords: risk evaluation; value at risk; Basel backtesting and capital charge; G18; G21; G28; G32

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Author's Biography

Jens Fricke is a senior project manager within the group strategy department in a financial institution. His research at the University of Osnabruück, Germany covers financial time series and risk management.

Ralf Pauly is a Professor Emeritus of Statistics and Econometrics at the University of Osnabruück, Germany. His main research interests are time series and financial market analysis as well as risk management.

Citation

Fricke, Jens and Pauly, Ralf (2012, September 1). Evaluation of the Basel VaR-based market risk charge and proposals for a needed adjustment. In the Journal of Risk Management in Financial Institutions, Volume 5, Issue 4. https://doi.org/10.69554/XSWC5125.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 5 / Issue 4
© Henry Stewart
Publications LLP

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