Impact of Expected Shortfall Approach on Capital Requirement Under Basel

Abstract

This paper proposes a method that uses volatility index of US and six other markets of Pacific Basin, namely Hong Kong, Australia, India, Japan, Korea, and China, to provide value-at-risk (VaR) and expected shortfall (ES) forecasts. Empirical constants that are used to multiply the levels of volatility indexes for estimating VaR and ES of various significance levels for 1–22 days ahead, one by one, for seven market indexes have been statistically determined using daily data spanning from 4.75 to 16 years. It is because it would be inappropriate to simply scale up the one-day volatility by multiplying the square root of time (or the number of days) ahead to determine the risk over a longer horizon of [Formula: see text] days. Results show that the shift to ES approach generally increases the regulatory capital requirements from 2.09% of India market to 8.56% of Korea market except for the China market where ES approach yields an unexpected decrease of 3.21% of capital requirement.