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The Cost of Conservatism: Extreme Returns, Value-at-Risk, and the Basle `Multiplication Factor'
Jon Danielsson, Casper de Vries and Philipp Hartmann
In this article we point to several important facts, which we feel have been neglected in the discussion about VaR models in general and the Basle internal models approach in particular. We argue that the current set of Basle requirements still provides disincentives for the development of more reliable VaR models, and show that considerable improvement of current VaR models is possible by means of techniques that explicitly focus on the properties of extreme return fluctuations. We then briefly discuss how a change in the determination of the Basle 'multiplication factor' may encourage the industry to adopt improved VaR models, such as those proposed here.