Developing a stress testing framework based on market risk models

Alexander, Carol and Sheedy, Elizabeth (2008) Developing a stress testing framework based on market risk models. Journal of Banking & Finance, 32 (10). pp. 2220-2236. ISSN 0378-4266

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Abstract

The Basel 2 Accord requires regulatory capital to cover stress tests, yet no coherent and objective framework for stress testing portfolios exists. We propose a new methodology for stress testing in the context of market risk models that can incorporate both volatility clustering and heavy tails. Empirical results compare the performance of eight risk models with four possible conditional and unconditional return distributions over different rolling estimation periods. When applied to major currency pairs using daily data spanning more than 20 years we find that stress test results should have little impact on current levels of foreign exchange regulatory capital.

Item Type: Article
Keywords: Value-at-Risk models; Stress testing; Market risk; Exchange rates; GARCH
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences > HG Finance
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Depositing User: Carol Alexander
Date Deposited: 11 Sep 2012 13:46
Last Modified: 11 Sep 2012 13:46
URI: http://sro.sussex.ac.uk/id/eprint/40624
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