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A cost-benefit analysis of capital requirements adjusted for model risk

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journal contribution
posted on 2023-06-09, 21:49 authored by Walter Farkas, Fulvia Fringuellotti, Radu TunaruRadu Tunaru
Capital adequacy is the key microprudential and macroprudential tool of banking regulation. Financial models of capital adequacy are subject to errors, which may prevent from estimating a sufficient capital base to absorb bank losses during economic downturns. In this paper, we propose a general method to account for model risk in capital requirements calculus related to market risk. We then evaluate and compare our capital requirements values with those obtained under Basel 2.5 and the new Basel 4 regulation. Capital requirements adjusted for model risk perform well in containing losses generates in normal and stressed times. In addition, they are as conservative as Basel 4 capital requirements, but they exhibit less fluctuations over time.

History

Publication status

  • Published

File Version

  • Accepted version

Journal

Journal of Corporate Finance

ISSN

0929-1199

Publisher

Elsevier

Volume

65

Page range

1-22

Article number

a101753

Department affiliated with

  • Accounting and Finance Publications

Full text available

  • Yes

Peer reviewed?

  • Yes

Legacy Posted Date

2020-10-08

First Open Access (FOA) Date

2022-04-22

First Compliant Deposit (FCD) Date

2020-10-07

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