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Robust capital requirements with model risk


Barrieu, Pauline; Ravanelli, Claudia (2015). Robust capital requirements with model risk. Economic Notes, 44(1):1-28.

Abstract

We study capital requirements when the bank's econometric model only approximately describes the dynamics of portfolio returns—which is virtually always the case in practice. We derive a simple formula for capital requirements based on a first-order Taylor expansion of the Value at Risk around a ‘model confidence’ parameter. This formula allows to reflect the bank's confidence in the econometric model into capital requirements in a theoretically consistent manner. Numerical and empirical applications show that our formula provides valuable information for quantifying capital requirements under model risk.

Abstract

We study capital requirements when the bank's econometric model only approximately describes the dynamics of portfolio returns—which is virtually always the case in practice. We derive a simple formula for capital requirements based on a first-order Taylor expansion of the Value at Risk around a ‘model confidence’ parameter. This formula allows to reflect the bank's confidence in the econometric model into capital requirements in a theoretically consistent manner. Numerical and empirical applications show that our formula provides valuable information for quantifying capital requirements under model risk.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2015
Deposited On:20 Aug 2014 14:54
Last Modified:05 Apr 2016 18:20
Publisher:Wiley-Blackwell
ISSN:0391-5026
Publisher DOI:https://doi.org/10.1111/ecno.12025
Official URL:http://onlinelibrary.wiley.com/doi/10.1111/ecno.12025/full
Related URLs:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2295959
Other Identification Number:merlin-id:9911

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