Capital requirements for market risks

Abstract

Purpose -The financial crisis has led the Basel Committee to improve the system of capital requirements for market risks. This paper aims to investigate the effects of different models to estimate the market risk in the management of the trading book. The study takes into account the events occurring in the financial markets and the new prudential rules. Design/methodology/approach -The author compares different models and proposes an opportunity cost function able to evaluate the cost related to capital requirements. He identified seven asset classes and studies the effects of different models for estimating VaR simulating financial portfolios with increasing risk. The series consists of the daily return from 01/01/2002 to 06/30/2012. Findings -The results show that it is possible to identify a wide area between aggressive and conservative approach where the bank management must choose. The regulation does not encourage intermediaries to the use of complex models that could better evaluate the risk in financial markets. The revision of the market risk framework increases the capital requirement and reduces the incentive to use models with more predictive power for regulatory purposes. Originality/value -The work differs from previous contributions for three characteristics: first, it uses a set of extended data and more consistent with the actual operation. Secondly, the author presents an opportunity cost function in order to evaluate the estimation models. Third, he calculates the effect of stressed-VaR after a year and a half of adoption.

The Fundamental Review of the Trading Book: Implications for Portfolio and Risk Management in the Banking Sector

“…This indicates that the choice of risk model is not a priority concern in the FRTB framework. This is consistent with the findings of Burchi (2013), who argues that the increased complexity of the regulatory framework nullifies the significance of the choice of resolution model.…”

“…We add to this emerging literature with our quantitative impact study, building on an established literature examining the role of VaR within the Basel II capital regulation framework (e.g., the studies by Borio 2003, Angelidis and Degiannakis 2009, Rossignolo, Fethi, and Shaban 2012, Burchi 2013). The comprehensive nature of the FRTB framework for the calculation of market risk capital addresses many of the key concerns raised by industry and commentators.…”

“…There are a number of studies that examine the performance of different risk models in the determination of market risk capital (e.g., Rossignolo, Fethi, and Shaban 2012, Burchi 2013). Berkowitz and O'Brien (2002) observe the deployment of conservative models that lack the ability to respond to changing volatility.…”

The Basel 2.5 capital regulatory framework and the COVID-19 crisis: evidence from the ethical investment market

“…Empirical literature on VaR models under the market risk regulation Several studies examined how financial institutions are dealing with the sVaR proposed by Basel II.5 (Berner, 2010;Rossignolo et al, 2012Rossignolo et al, , 2013Burchi, 2013;Prorokowski and Prorokowski, 2014). They consider that the MCR under the new Basel regulations provides adequate coverage for larger losses during periods of financial turmoil.…”

“…Besides, it raises the market capital requirement and reduces the incentive to use techniques with higher predictive ability (Berner, 2010). Finally, it gives a comprehensive assessment of market risk (Burchi, 2013;Prorokowski and Prorokowski, 2014). Other researchers are concerned about the suitability of VaR models under the Basel II.5, especially when they evaluate several approaches in the context of different conventional stock markets.…”