An extreme value theory approach to calculating minimum capital risk requirements

Brooks, C. ORCID: https://orcid.org/0000-0002-2668-1153, Clare, A.D. and Persand, G. (2002) An extreme value theory approach to calculating minimum capital risk requirements. Journal of Risk Finance, 3 (2). pp. 22-33. ISSN 1526-5943 doi: 10.1108/eb043485

Abstract/Summary

This paper investigates the frequency of extreme events for three LIFFE futures contracts for the calculation of minimum capital risk requirements (MCRRs). We propose a semiparametric approach where the tails are modelled by the Generalized Pareto Distribution and smaller risks are captured by the empirical distribution function. We compare the capital requirements form this approach with those calculated from the unconditional density and from a conditional density - a GARCH(1,1) model. Our primary finding is that both in-sample and for a hold-out sample, our extreme value approach yields superior results than either of the other two models which do not explicitly model the tails of the return distribution. Since the use of these internal models will be permitted under the EC-CAD II, they could be widely adopted in the near future for determining capital adequacies. Hence, close scrutiny of competing models is required to avoid a potentially costly misallocation capital resources while at the same time ensuring the safety of the financial system.

Item Type	Article
URI	https://reading-clone.eprints-hosting.org/id/eprint/24159
Item Type	Article
Refereed	Yes
Divisions	Henley Business School > Finance and Accounting
Uncontrolled Keywords	Minimum Capital Risk Requirements, Generalized Pareto Distribution, GARCH models
Publisher	Emerald
Publisher Statement	This article is (c) Emerald Group Publishing and permission has been granted for this version to appear here (centaur.reading.ac.uk). Emerald does not grant permission for this article to be further copied/distributed or hosted elsewhere without the express permission from Emerald Group Publishing Limited. The definitive version can be found at http://www.emeraldinsight.com/journals.htm?articleid=1659741
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