A word of caution on calculating market -based minimum capital risk requirements
A word of caution on calculating market -based minimum capital risk requirements
This paper demonstrates that the use of GARCH-type models for the calculation of minimum capital risk requirements (MCRRs) may lead to the production of inaccurate and therefore inefficient capital requirements. We show that this inaccuracy stems from the fact that GARCH models typically overstate the degree of persistence in return volatility. A simple modification to the model is found to improve the accuracy of MCRR estimates in both back- and out-of-sample tests. Given that internal risk management models are currently in widespread usage in some parts of the world (most notably the USA), and will soon be permitted for EC banks and investment firms, we believe that our paper should serve as a valuable caution to risk management practitioners who are using, or intend to use this popular class of models.
minimum capital risk requirements, internal risk management models, volatility persistence
1557-1574
Brooks, C.
91d99e42-37f5-4b2b-87a2-c3df0c926b5f
Clare, A.D.
e9a9923a-dee5-4521-a5e1-d404befa7069
Persand, G.
c1b50342-bfb4-4a40-9f03-b352ba2076f2
2000
Brooks, C.
91d99e42-37f5-4b2b-87a2-c3df0c926b5f
Clare, A.D.
e9a9923a-dee5-4521-a5e1-d404befa7069
Persand, G.
c1b50342-bfb4-4a40-9f03-b352ba2076f2
Brooks, C., Clare, A.D. and Persand, G.
(2000)
A word of caution on calculating market -based minimum capital risk requirements.
Journal of Banking and Finance, 24 (10), .
(doi:10.1016/S0378-4266(99)00092-8).
Abstract
This paper demonstrates that the use of GARCH-type models for the calculation of minimum capital risk requirements (MCRRs) may lead to the production of inaccurate and therefore inefficient capital requirements. We show that this inaccuracy stems from the fact that GARCH models typically overstate the degree of persistence in return volatility. A simple modification to the model is found to improve the accuracy of MCRR estimates in both back- and out-of-sample tests. Given that internal risk management models are currently in widespread usage in some parts of the world (most notably the USA), and will soon be permitted for EC banks and investment firms, we believe that our paper should serve as a valuable caution to risk management practitioners who are using, or intend to use this popular class of models.
This record has no associated files available for download.
More information
Published date: 2000
Keywords:
minimum capital risk requirements, internal risk management models, volatility persistence
Organisations:
Management
Identifiers
Local EPrints ID: 35884
URI: http://eprints.soton.ac.uk/id/eprint/35884
ISSN: 0378-4266
PURE UUID: d942da7e-021f-4ca0-a7c0-db8e19f344ec
Catalogue record
Date deposited: 23 May 2006
Last modified: 15 Mar 2024 07:54
Export record
Altmetrics
Contributors
Author:
C. Brooks
Author:
A.D. Clare
Author:
G. Persand
Download statistics
Downloads from ePrints over the past year. Other digital versions may also be available to download e.g. from the publisher's website.
View more statistics