Forum for Science, Industry and Business

Sponsored by:     3M 
Search our Site:

 

Study Shows Bank Risk-Assessment Tool Not Responding Adequately to Market Fluctuations

27.05.2009
A new study from North Carolina State University indicates that regulators need to do more to ensure that banks are adequately computing their Value-at-Risk (VaR) to reflect fluctuations in financial markets.

The study finds that the tests used by regulators do not detect when VaRs inaccurately account for significant swings in the market, which is significant because VaRs are key risk-assessment tools financial institutions use to determine the amount of capital they need to keep on hand to cover potential losses.

"Failing to modify the VaR to reflect market fluctuations is important," study co-author Dr. Denis Pelletier says, "because it could lead to a bank exhausting its on-hand cash reserves." Pelletier, an assistant professor of economics at NC State, says "Problems can come up if banks miscalculate their VaR and have insufficient funds on hand to cover their losses."

VaRs are a way to measure the risk exposure of a company's portfolio. Economists can determine the range of potential future losses and provide a statistical probability for those losses. For example, there may be a 10 percent chance that a company could lose $1 million. The VaR is generally defined as the point at which a portfolio stands only a one percent chance of taking additional losses.

In other words, the VaR is not quite the worst-case scenario – but it is close. The smaller a company's VaR, the less risk a portfolio is exposed to. If a company's portfolio is valued at $1 billion, for example, a VaR of $15 million is significantly less risky than a VaR of $25 million.

The NC State study indicates that regulators could use additional tests to detect when the models used by banks are failing to accurately assess the statistical probability of losses in financial markets. The good news, Pelletier says, is that the models banks use tend to be overly conservative – meaning they rarely lose more than their VaR. But the bad news is that bank models do not adjust the VaR quickly when the market is in turmoil – meaning that when the banks are wrong and "violate" or lose more than their VaR – they tend to be wrong multiple times in a short period of time.

This could have serious consequences, Pelletier explains. "For example, if a bank has a VaR of $100 million it would keep at least $300 million in reserve, because banks are typically required to keep three to five times the VaR on hand in cash as a capital reserve. So it could afford a bad day – say, $150 million in losses. However, it couldn't afford several really bad days in a row without having to sell illiquid assets, putting the bank further in distress."

Banks are required to calculate their VaR on a daily basis by various regulatory authorities, such as the Federal Deposit Insurance Corporation. Pelletier says the new study indicates that regulatory authorities need to do more to ensure that banks are using dynamic models – and don't face multiple VaR violations in a row.

The study, "Evaluating Value-at-Risk Models with Desk-Level Data," was co-authored by Pelletier, Jeremy Berkowitz of the University of Houston and Peter Christoffersen of McGill University. The study will be published in a forthcoming special issue of Management Science on interfaces of operations and finance.

Matt Shipman | EurekAlert!
Further information:
http://www.ncsu.edu

More articles from Business and Finance:

nachricht Mathematical confirmation: Rewiring financial networks reduces systemic risk
22.06.2017 | International Institute for Applied Systems Analysis (IIASA)

nachricht Frugal Innovations: when less is more
19.04.2017 | Fraunhofer-Institut für Arbeitswirtschaft und Organisation IAO

All articles from Business and Finance >>>

The most recent press releases about innovation >>>

Die letzten 5 Focus-News des innovations-reports im Überblick:

Im Focus: Can we see monkeys from space? Emerging technologies to map biodiversity

An international team of scientists has proposed a new multi-disciplinary approach in which an array of new technologies will allow us to map biodiversity and the risks that wildlife is facing at the scale of whole landscapes. The findings are published in Nature Ecology and Evolution. This international research is led by the Kunming Institute of Zoology from China, University of East Anglia, University of Leicester and the Leibniz Institute for Zoo and Wildlife Research.

Using a combination of satellite and ground data, the team proposes that it is now possible to map biodiversity with an accuracy that has not been previously...

Im Focus: Climate satellite: Tracking methane with robust laser technology

Heatwaves in the Arctic, longer periods of vegetation in Europe, severe floods in West Africa – starting in 2021, scientists want to explore the emissions of the greenhouse gas methane with the German-French satellite MERLIN. This is made possible by a new robust laser system of the Fraunhofer Institute for Laser Technology ILT in Aachen, which achieves unprecedented measurement accuracy.

Methane is primarily the result of the decomposition of organic matter. The gas has a 25 times greater warming potential than carbon dioxide, but is not as...

Im Focus: How protons move through a fuel cell

Hydrogen is regarded as the energy source of the future: It is produced with solar power and can be used to generate heat and electricity in fuel cells. Empa researchers have now succeeded in decoding the movement of hydrogen ions in crystals – a key step towards more efficient energy conversion in the hydrogen industry of tomorrow.

As charge carriers, electrons and ions play the leading role in electrochemical energy storage devices and converters such as batteries and fuel cells. Proton...

Im Focus: A unique data centre for cosmological simulations

Scientists from the Excellence Cluster Universe at the Ludwig-Maximilians-Universität Munich have establised "Cosmowebportal", a unique data centre for cosmological simulations located at the Leibniz Supercomputing Centre (LRZ) of the Bavarian Academy of Sciences. The complete results of a series of large hydrodynamical cosmological simulations are available, with data volumes typically exceeding several hundred terabytes. Scientists worldwide can interactively explore these complex simulations via a web interface and directly access the results.

With current telescopes, scientists can observe our Universe’s galaxies and galaxy clusters and their distribution along an invisible cosmic web. From the...

Im Focus: Scientists develop molecular thermometer for contactless measurement using infrared light

Temperature measurements possible even on the smallest scale / Molecular ruby for use in material sciences, biology, and medicine

Chemists at Johannes Gutenberg University Mainz (JGU) in cooperation with researchers of the German Federal Institute for Materials Research and Testing (BAM)...

All Focus news of the innovation-report >>>

Anzeige

Anzeige

Event News

Plants are networkers

19.06.2017 | Event News

Digital Survival Training for Executives

13.06.2017 | Event News

Global Learning Council Summit 2017

13.06.2017 | Event News

 
Latest News

Quantum thermometer or optical refrigerator?

23.06.2017 | Physics and Astronomy

A 100-year-old physics problem has been solved at EPFL

23.06.2017 | Physics and Astronomy

Equipping form with function

23.06.2017 | Information Technology

VideoLinks
B2B-VideoLinks
More VideoLinks >>>