Analytical Method of Computing Stressed Value-at-Risk with Conditional Value-at-Risk

Abstract

This paper develops an analytical form of stressed value-at-risk (analytical SVaR), one of the most important changes implemented by Basel II, using conditional value-at-risk (CoVaR). We also validate analytical SVaR empirically and theoretically. The proposed analytical risk measure can be readily applied to the existing risk-management framework. It is a computationally inexpensive tool for screening conditional portfolio risk, is reasonably accurate and has desirable statistical properties. It is suitable for use by any business that evaluates conditional financial risk with respect to market conditions. The theoretical result of this paper also suggests that CoVaR may fail to properly capture conditional risk when it is most pronounced.

Keywords: conditional risk, conditional value-at-risk (CoVaR), delta-normal method, stressed value-at-risk (SVaR), risk management