Value at Risk, Legislative Framework, Crises, and Procyclicality: What Goes Wrong?

Review of Economic Analysis, Forthcoming

28 Pages Posted: 7 Jan 2020

See all articles by Evangelos Vasileiou

Evangelos Vasileiou

University of the Aegean, Department of Financial and Management Engineering

Aristeidis Samitas

University of the Aegean

Date Written: December 16, 2019

Abstract

This study highlights some deficiencies of the stock markets’ risk legislation framework, and particularly the CESR (2010) guidelines. We show that the current legislative framework fails to offer incentives to financial management companies to invest in advanced models for more representative Value at Risk (VaR) estimations, and for this reason, in many cases conventional VaR models are applied. We use data from the DAX, CAC 40, FTSE, FTSEMIB and IBEX indices, and then we apply them to the widely accepted Delta Normal VaR model. The empirical findings show that the conventional VaR models not only fail to provide information for the upcoming financial crises, but also contribute to such phenomena as procyclicality and overreaction in the stock market. We suggest additional tests and we empirically show how these tests could reduce the procyclicality issue and promote a more sustainable investment environment. Even though this study is mainly focused on CESR (2010) guidelines, it could be useful for any similar legislative framework, such as the Basel Accords.

Keywords: Financial regulation; Value at Risk; Procyclicality

JEL Classification: D81; G32

Suggested Citation

Vasileiou, Evangelos and Samitas, Aristeidis, Value at Risk, Legislative Framework, Crises, and Procyclicality: What Goes Wrong? (December 16, 2019). Review of Economic Analysis, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3504544

Evangelos Vasileiou (Contact Author)

University of the Aegean, Department of Financial and Management Engineering ( email )

45, Kountourgiotou str.
Chios, GA 82100
Greece

Aristeidis Samitas

University of the Aegean ( email )

8 Michalon str.
Chios
Greece

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