This paper proposes a new model for computing Value-at-Risk forecasts. To summarize, it incorporates information about the market’s perceived uncertainty about the future from volatility indices. By comparing the model primarily used in the banking sector to our new model, the authors found that a financial institution using our model has on average a lower market induced capital requirement (MCR). However, during the time period leading up to the financial crises our model gives a 40% higher MCR.
KYOS has incorporated Value-at-Risk (VaR) into its platform of analytical models. Value-at-Risk helps risks managers and traders to manage market risk on a portfolio of positions. It is the standard risk concept in most trading organisations. It gives insight in potential future losses and helps to take the right measures. Furthermore, it is possible to adjust positions, execute new transactions (hedges), or employ more capital as a buffer.
The standard VaR model in the KYOS Analytical Platform is based on the variance-covariance matrix. Other words to describe the same method are parametric VaR, normal VaR or varcovar VaR. It is actually the most easy to use and interpret results. As an input it requires the volatilities and correlations of all monthly prices. The model calculates these parameters then automatically, and base them on historical market prices. Additionally, the user may overwrite the volatility estimates, either to test sensitivities or because he has more accurate estimates from option markets.
As alternative methodologies, KYOS offers the Monte Carlo simulation approach and the historical simulation approach. Especially when the market price returns do not have a very nice Normal distribution, this may be more accurate. For the Monte Carlo simulation approach, the price simulations from KySim are used. For the historical simulation approach, the model takes the variations in market prices directly from the history, without any distribution assumption; that is therefore the non-parametric VaR approach.
Published in Journal of Risk, Vol. 16, No. 4, 2014
Authors: Marcus Nossman (KYOS) and Anders Vilhelmsson
► click here to download
Nieuwe Gracht 49
2011 ND Haarlem
Tel: +31 (0)23 551 02 21
Contact us via the form below. We will reply within 48 hours.