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The Ten Commandments for Managing Value-at-Risk Under the Basel II Accord

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The Ten Commandments for Managing Value-at-Risk Under the Basel II Accord

Jack Sparrow: “The only rules that really matter are these: what a man can do and what a man can’t do.”
Elizabeth: “You’re pirates. Hang the code, and hang the rules. They’re more like guidelines anyway.”
Jack Sparrow: “I thought you were supposed to keep to the code.”
Mr. Gibbs: “We figured they were more actual guidelines.”

Pirates of the Caribbean: Curse of the Black Pearl

Juan-Ángel Jiménez-Martín, Michael McAleer, Teodosio Pérez-Amaral

Department of Quantitative Economics
Complutense University of Madrid
March 2009

ABSTRACT:  Under the Basel II Accord, banks and other Authorized Deposit-taking Institutions (ADIs) are required to communicate their daily market risk estimates to the relevant national monetary authority at the beginning of each trading day, using one of a variety of Value-at-Risk (VaR) models to measure risk. The purpose of this paper is to provide a simple explanation and a set of prescriptions for managing VaR under the Basel II Accord. The commandments deal with understanding the Basel II colours, understanding the risk model before choosing, varying the choice of risk model, avoiding the green zone and being willing to violate, incurring large violations, stopping before the red zone, avoiding frequent violations, avoiding the estimation of large portfolios, aggregating portfolios into a single index, and interpreting commandments sensibly as guidelines.




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