Backtesting Basel III: evaluating the market risk of past crises through the current regulation



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Administração e Economia de Negócios

Marcelo Zeuli, André Carvalhal



Applied Economics, v. 50, n. 59, pp. 6382-6396. Abstract: Are the recommendations from the Bank for International Settlements (BIS) effective to a broad set of financial crises? We submitted two of the main Basel III recommendations for market risk to a back test: the capital requirements and the Value at Risk (VaR) methodology that includes the BIS’s Stressed VaR. We tested the main Brazilian currency exchange (U.S. Dollar to Brazilian Reais) and currency exchange swaps contracts through volatility-based VaR methodologies in the period that comprises the so-called Brazilian confidence crisis, which occurred in the second half of 2002. While the Stressed VaR revealed inapplicable, due to historical data shortage, the capital requirements level appeared innocuous, due to the high levels of daily volatility – daily oscillation limits may have a significant role on crisis mitigation. To circumvent the lack of either historical information or optimal window for stress patterns, we suggest to calibrate the Stressed VaR or the recently announced Expected Shortfall with a historical VIX (Volatility Index, Chicago Board Options Exchange), working as a volatility scale. We suggest modelling with other densities, apart from the BIS recommended standard normal.

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