Download This PaperExternal Risk Measures and Basel Accords
Kou, S. G., Peng, X., Heyde, C. C., 2013. Mathematics of Operations Research 38 (3), 393-417.
27 Pages Posted: 12 May 2012 Last revised: 3 Aug 2013
Date Written: August 1, 2013
Abstract
Choosing a proper external risk measure is of great regulatory importance, as exemplified in the Basel II and Basel III Accord which use Value-at-Risk (VaR) with scenario analysis as the risk measures for setting capital requirements. We argue a good external risk measure should be robust with respect to model misspecification and small changes in the data. A new class of data-based risk measures called natural risk statistics are proposed to incorporate robustness. Natural risk statistics are characterized by a new set of axioms; they include the Basel II and III risk measures and a subclass of robust risk measures as special cases; therefore, they provide a theoretical framework for understanding and, if necessary, extending the Basel accords.
Keywords: financial regulation, capital requirements, risk measure, scenario analysis, robustness, value-at-risk, expected shortfall, tail conditional expectation
JEL Classification: G18, G28, G32, K20, K23
Suggested Citation: Suggested Citation