A word of caution on calculating market-based minimum capital risk requirements

Brooks, C. ORCID: https://orcid.org/0000-0002-2668-1153, Clare, A. D. and Persand, G. (2000) A word of caution on calculating market-based minimum capital risk requirements. Journal of Banking & Finance, 24 (10). pp. 1557-1574. ISSN 0378-4266 doi: 10.1016/S0378-4266(99)00092-8

Abstract/Summary

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.

Item Type	Article
URI	https://reading-clone.eprints-hosting.org/id/eprint/35965
Identification Number/DOI	10.1016/S0378-4266(99)00092-8
Refereed	Yes
Divisions	Henley Business School > Finance and Accounting
Publisher	Elsevier
Download/View statistics	View download statistics for this item