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Extended Value at Risk (EVaR) Measure for Market Risk

Mo Chaudhury

McGill University - Desautels Faculty of Management

April 12, 2011

In July 2009, following the financial crisis, the Basel Committee on Banking Supervision made changes to the Value at Risk (VaR) framework for the market risk capital of bank trading books. While the new rule boosts capital standards, the capital requirement seems overly burdensome and not sufficiently responsive to market dynamics. It also increases model risk and opaqueness of capital estimates.

Chaudhury (2011) recently reported that the extreme tail risk of US stock portfolios during the recent financial crisis was primarily driven by the unprecedented rise in unconditional volatility.

Building upon this observation, this paper proposes an Extended Value at Risk (EVaR) measure for market risk that retains the spirit of the new Basel rule, but uses a much simpler and standardized framework that includes the widely popular Normal distribution and implied volatility of options. The EVaR measure is responsive to market dynamics, transparent, easy to implement, and can be customized for various internal uses by banks including economic capital estimation. Also, it is not onerous in terms of regulatory capital in normal market circumstances while allowing the building of a capital buffer. Empirically this is illustrated using the S&P 500 portfolio as the trading book.

Number of Pages in PDF File: 12

Keywords: Market Risk, Value at Risk, Implied Volatility, Basel, Bank Capital

JEL Classification: G13, G21, G01

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Date posted: April 16, 2011 ; Last revised: September 18, 2011

Suggested Citation

Chaudhury, Mo, Extended Value at Risk (EVaR) Measure for Market Risk (April 12, 2011). Available at SSRN: http://ssrn.com/abstract=1809801 or http://dx.doi.org/10.2139/ssrn.1809801

Contact Information

Mo Chaudhury (Contact Author)
McGill University - Desautels Faculty of Management ( email )
1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
(514) 398-5927 (Phone)
(514) 398-3876 (Fax)
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