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Diversification and Value-at-Risk
Year Of Publication: 2008
Month Of Publication: September
Pages: 29
Download Count: 213
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Comment Num: 0
Language: EN
Source: article
Who Can Read: Free
Date: 11-25-2007
Publisher: Administrator
A pervasive and puzzling feature of banks’ Value at Risk (VaR) is its abnormally highlevel, which leads to excessive regulatory capital. A possible explanation for the tendencyof commercial banks to overstate their VaR is that they incompletely account for thediversification effect among broad risk categories (e.g. equity, interest rate, commodity,credit spread, and foreign exchange). By underestimating the diversification effect,bank’s proprietary VaR models produce overly prudent market risk assessments. In thispaper, we examine empirically the validity of this theory using actual VaR data frommajor US commercial banks. In contrast to the VaR diversification theory, we find thatUS banks show no sign of systematic underestimation of the diversification effect. Inparticular, diversification effect used by banks is very close to (and quite often largerthan) our empirical diversification estimate
This document is published in Journal of Banking and Finance (volume 34, number 1) January 2010, 55-66.
Perignon, Christophe Sign in to follow this author
Smith, Daniel R. Sign in to follow this author
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