Lambda Value at Risk and Regulatory Capital: A Dynamic Approach to Tail Risk

20 Pages Posted: 15 Mar 2017 Last revised: 23 Mar 2018

See all articles by Asmerilda Hitaj

Asmerilda Hitaj

Università degli Studi di Milano-Bicocca - Dipartimento di Statistica e Metodi Quantitativi

Cesario Mateus

Aalborg University

Ilaria Peri

University of London - Economics, Mathematics and Statistics

Date Written: February 26, 2018

Abstract

This paper presents the first methodological proposal of estimation of the Lambda VaR. Our approach is dynamic and calibrated to market extreme scenarios, incorporating the need of regulators and financial institutions in more sensitive risk measures. We also propose a simple backtesting methodology by extending the VaR hypothesis-testing framework. Hence, we test our Lambda VaR proposals under extreme downward scenarios of the financial crisis and different assumptions on the profit and loss distribution. The findings show that our Lambda VaR estimations are able to capture the tail risk and react to market fluctuations significantly faster than the VaR and expected shortfall. The backtesting exercise displays a higher level of accuracy for our Lambda VaR estimations.

Keywords: banking regulation, financial risk management, risk modelling, value at risk

JEL Classification: C53, G01, G32

Suggested Citation

Hitaj, Asmerilda and Mateus, Cesario and Peri, Ilaria, Lambda Value at Risk and Regulatory Capital: A Dynamic Approach to Tail Risk (February 26, 2018). Available at SSRN: https://ssrn.com/abstract=2932475 or http://dx.doi.org/10.2139/ssrn.2932475

Asmerilda Hitaj

Università degli Studi di Milano-Bicocca - Dipartimento di Statistica e Metodi Quantitativi ( email )

Milano, 20126
Italy

Cesario Mateus

Aalborg University

Fredrik Bajers Vej 7E
Aalborg, DK-9220
Denmark

Ilaria Peri (Contact Author)

University of London - Economics, Mathematics and Statistics ( email )

United States

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