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 Microtechnology industry is hiring – positive developments of past years continue
09.04.2018 | IVAM Fachverband für Mikrotechnik

nachricht RWI/ISL-Container Throughput Index with minor decline on a high overall level
20.03.2018 | RWI – Leibniz-Institut für Wirtschaftsforschung

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: Future electronic components to be printed like newspapers

A new manufacturing technique uses a process similar to newspaper printing to form smoother and more flexible metals for making ultrafast electronic devices.

The low-cost process, developed by Purdue University researchers, combines tools already used in industry for manufacturing metals on a large scale, but uses...

Im Focus: First evidence on the source of extragalactic particles

For the first time ever, scientists have determined the cosmic origin of highest-energy neutrinos. A research group led by IceCube scientist Elisa Resconi, spokesperson of the Collaborative Research Center SFB1258 at the Technical University of Munich (TUM), provides an important piece of evidence that the particles detected by the IceCube neutrino telescope at the South Pole originate from a galaxy four billion light-years away from Earth.

To rule out other origins with certainty, the team led by neutrino physicist Elisa Resconi from the Technical University of Munich and multi-wavelength...

Im Focus: Magnetic vortices: Two independent magnetic skyrmion phases discovered in a single material

For the first time a team of researchers have discovered two different phases of magnetic skyrmions in a single material. Physicists of the Technical Universities of Munich and Dresden and the University of Cologne can now better study and understand the properties of these magnetic structures, which are important for both basic research and applications.

Whirlpools are an everyday experience in a bath tub: When the water is drained a circular vortex is formed. Typically, such whirls are rather stable. Similar...

Im Focus: Breaking the bond: To take part or not?

Physicists working with Roland Wester at the University of Innsbruck have investigated if and how chemical reactions can be influenced by targeted vibrational excitation of the reactants. They were able to demonstrate that excitation with a laser beam does not affect the efficiency of a chemical exchange reaction and that the excited molecular group acts only as a spectator in the reaction.

A frequently used reaction in organic chemistry is nucleophilic substitution. It plays, for example, an important role in in the synthesis of new chemical...

Im Focus: New 2D Spectroscopy Methods

Optical spectroscopy allows investigating the energy structure and dynamic properties of complex quantum systems. Researchers from the University of Würzburg present two new approaches of coherent two-dimensional spectroscopy.

"Put an excitation into the system and observe how it evolves." According to physicist Professor Tobias Brixner, this is the credo of optical spectroscopy....

All Focus news of the innovation-report >>>

Anzeige

Anzeige

VideoLinks
Industry & Economy
Event News

Leading experts in Diabetes, Metabolism and Biomedical Engineering discuss Precision Medicine

13.07.2018 | Event News

Conference on Laser Polishing – LaP: Fine Tuning for Surfaces

12.07.2018 | Event News

11th European Wood-based Panel Symposium 2018: Meeting point for the wood-based materials industry

03.07.2018 | Event News

 
Latest News

A smart safe rechargeable zinc ion battery based on sol-gel transition electrolytes

20.07.2018 | Power and Electrical Engineering

Reversing cause and effect is no trouble for quantum computers

20.07.2018 | Information Technology

Princeton-UPenn research team finds physics treasure hidden in a wallpaper pattern

20.07.2018 | Materials Sciences

VideoLinks
Science & Research
Overview of more VideoLinks >>>