Has the Basel II Accord Encouraged Risk Management During the 2008-09 Financial Crisis?
Erasmus University Rotterdam - Erasmus School of Economics, Econometric Institute; Tinbergen Institute; University of Tokyo - Centre for International Research on the Japanese Economy (CIRJE), Faculty of Economics
Complutense University of Madrid
Teodosio Perez Amaral
Complutense University of Madrid - Facultad de Económicas y Empresariales
January 24, 2010
The Basel II Accord requires that banks and other Authorized Deposit-taking Institutions (ADIs) communicate their daily risk forecasts to the appropriate monetary authorities at the beginning of each trading day, using one or more risk models to measure Value-at-Risk (VaR). The risk estimates of these models are used to determine capital requirements and associated capital costs of ADIs, depending in part on the number of previous violations, whereby realised losses exceed the estimated VaR. In this paper we define risk management in terms of choosing sensibly from a variety of risk models, and discuss the selection of optimal risk models. A new approach to model selection for predicting VaR is proposed, consisting of combining alternative risk models, and comparing conservative and aggressive strategies for choosing between VaR models. We then examine how different risk management strategies performed during the 2008-09 financial crisis. These issues are illustrated using Standard and Poor’s 500 Index, with an emphasis on how market risk management practices were encouraged by the Basel II Accord regulations during the financial crisis.
Number of Pages in PDF File: 33
Keywords: Value-at-Risk (VaR), daily capital charges, exogenous and endogenous violations, violation penalties, optimizing strategy, risk forecasts, aggressive or conservative risk management strategies, Basel II Accord, financial crisis
JEL Classification: G32, G11, G17, C53, C22working papers series
Date posted: April 30, 2009 ; Last revised: January 27, 2010
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