Abstract
We model the new quantitative aspects of market risk management for banks that Basel established in 2016 and came into effect in January 2019. Market risk is measured by Conditional Value at Risk (CVaR) or Expected Shortfall at a confidence level of 97.5%. The regulatory backtest remains largely based on 99% VaR. As additional statistical procedures, in line with the Basel recommendations, supplementary VaR and CVaR backtests must be performed at different confidence levels. We apply these tests to various parametric distributions and use non-parametric measures of CVaR, including CVaR- and CVaR+ to supplement the modelling validation. Our data relate to a period of extreme market turbulence. After testing eight parametric distributions with these data, we find that the information obtained on their empirical performance is closely tied to the backtesting conclusions regarding the competing models.
Highlights
Despite all the advantages that securitization offers the economy and the financial system, the financial crisis that began in 2007 drew attention to the fact that advantageous financial innovations such as securitization can become a source of financial instability if industry practices and regulations do not keep pace with financial innovation (Selody and Woodman 2009)
Have shown that a fixed retention contract is optimal under moral hazard when the bank can only affect the loan default probability with its unobservable actions. We extend this contribution by permitting the bank to affect the conditional loss given default rate with its credit risk management activities
We investigate the optimal security design of structured products by analyzing explicit incentive contracting under moral hazard
Summary
Despite all the advantages that securitization offers the economy and the financial system, the financial crisis that began in 2007 drew attention to the fact that advantageous financial innovations such as securitization can become a source of financial instability if industry practices and regulations do not keep pace with financial innovation (Selody and Woodman 2009). Fender and Mitchell (2009a, 2009b) analyzed the effects of different contract forms (equity tranche, senior/mezzanine tranche, and vertical slice) on screening incentives but did not derive the optimal form of contracts endogenously. This may be problematic because the contract forms they studied may not be optimal even if they are currently observed.
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