The Ten Commandments for Managing Value-at-Risk under the Basel II Accord
10 Pages Posted: 11 Mar 2009 Last revised: 9 Aug 2009
Date Written: March 10, 2009
Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) are required to communicate their daily market risk estimates to the relevant national monetary authority at the beginning of each trading day, using one of a variety of Value-at-Risk (VaR) models to measure risk. The purpose of this paper is to provide a simple explanation and a set of prescriptions for managing VaR under the Basel II Accord. The commandments deal with understanding the Basel II colours, understanding the risk model before choosing, varying the choice of risk model, avoiding the green zone and being willing to violate, incurring large violations, stopping before the red zone, avoiding frequent violations, avoiding the estimation of large portfolios, aggregating portfolios into a single index, and interpreting commandments sensibly as guidelines.
Keywords: Financial portfolios, daily capital charges, frequency of violations, magnitude of violations, optimizing strategy, risk forecasts, value-at-risk, green zone, red zone
JEL Classification: G32, G11, G17
Suggested Citation: Suggested Citation