Stress Testing for Market Risk: A Comparison of VAR Methods

24 Pages Posted: 1 Apr 2009

See all articles by Sanjay Basu

Sanjay Basu

National Institute of Bank Management

Date Written: March 31, 2009

Abstract

The subprime crisis has shown us again that actual shocks in stressed markets are much more severe than historical scenarios. In this paper, we compare stress tests for foreign exchange positions, based on hypothetical scenarios, across a number of VaR methods. We conclude that volatility weighted historical simulation is the best one, because risk estimates change smoothly with the size of shocks and the impact of stress is also felt on short positions. It captures volatility clustering and fat tails in a simple framework.

Keywords: Volatility updation, Age-weighted simulation, diversification, Fat tails, nonparametric methods

JEL Classification: G21, G32

Suggested Citation

Basu, Sanjay, Stress Testing for Market Risk: A Comparison of VAR Methods (March 31, 2009). Available at SSRN: https://ssrn.com/abstract=1370965 or http://dx.doi.org/10.2139/ssrn.1370965

Sanjay Basu (Contact Author)

National Institute of Bank Management ( email )

Kondhwe Khurd, NIBM P.O.
Pune, WY Maharashtra 411048
India

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