Displaced Historical Simulation Improves Modeling of Possibly Negative-Valued Financial Risk Values: Application to VaR in Times of Negative Government Bond Yields
Christian P. Fries
LMU Munich, Department of Mathematics; DZ Bank AG
University of St. Gallen
VU University Amsterdam
December 14, 2013
In this paper we introduce the displaced relative change (DRC) model and the displaced filtered historical simulation (DFHS) model. These models make possible historical simulations based on potentially negative risk factors, such as interest rates or spreads. This is an issue of recent and major interest to the financial sector, both from a regulatory and financial institutions perspective, especially in light of observed negative values for government bond yields. Our empirical results show that compared to other models in the literature, models with our proposed displacement feature handle situations of close-to-zero or negative interest rates particularly well.
Number of Pages in PDF File: 27
Keywords: Historical simulation, generalizations, negative risk factors, Value at Risk
JEL Classification: C43, G17, G20, G30
Date posted: January 1, 2013 ; Last revised: December 15, 2013
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