External Risk Measures and Basel Accords

Authors:
Steven Kou;Xianhua Peng;Chris C. Heyde
Affiliations:
Department of Industrial Engineering and Operations Research, Columbia University, New York, New York 10027;Department of Mathematics, The Hong Kong University of Science and Technology, Kowloon, Hong Kong;-
Venue:
Mathematics of Operations Research
Year:
2013

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Abstract

Choosing a proper external risk measure is of great regulatory importance, as exemplified in the Basel II and Basel III Accords, which use value-at-risk with scenario analysis as the risk measures for setting capital requirements. We argue that a good external risk measure should be robust with respect to model misspecification and small changes in the data. A new class of data-based risk measures called natural risk statistics is proposed to incorporate robustness. Natural risk statistics are characterized by a new set of axioms. They include the Basel II and III risk measures and a subclass of robust risk measures as special cases; therefore, they provide a theoretical framework for understanding and, if necessary, extending the Basel Accords.