Value-at-Risk Model Risk

24 Pages Posted: 9 Feb 2011

See all articles by Carol Alexander

Carol Alexander

University of Sussex Business School; Peking University HSBC Business School

José María Sarabia

University of Cantabria - Department of Economics

Date Written: January 9, 2011


Large banks assess their regulatory capital for market risk using complex, firm-wide Value-at-Risk (VaR) models. In their 'bottom-up' approach to VaR there are many sources of model risk. A recent amendment to banking regulations requires additional market risk capital to cover all these model risks but, as yet, there is no accepted framework for computing such an add-on. We introduce a top-down approach to quantifying VaR model risk in a rigorous statistical framework and derive a corresponding adjustment to regulatory capital that is relatively straightforward to implement.

Keywords: Basel II, Maximum entropy, Model risk, Quantile, Risk capital, Value-at-Risk, VaR

JEL Classification: C1, C19, C51, G17, G28

Suggested Citation

Alexander, Carol and Sarabia, José María, Value-at-Risk Model Risk (January 9, 2011). Available at SSRN: or

Carol Alexander (Contact Author)

University of Sussex Business School ( email )

Falmer, Brighton BN1 9SL
United Kingdom


Peking University HSBC Business School ( email )

José María Sarabia

University of Cantabria - Department of Economics ( email )

Av. Los Castros s/n
39005 - Santander (Cantabria), Cantabria 39005

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