In recent years, there has been an unprecedented surge in the usage of risk management practices, with the Value-at-Risk (VaR)-based risk management emerging as the industry standard by choice or by regulation (Jorion, 1997). As a risk management technique, VaR describes the maximum loss that can occur over a given period, at a given confidence level, to a given portfolio due to exposure to market risk. It is a measure of potential loss, where the potential loss is linked directly to the probability of occurrence of large adverse movement in the market prices.
VaR
models have been sanctioned for determining market risk capital
requirements for large banks by US and international banking
authorities through the 1996 Market Risk Amendment to the
Basle Accord. Securities and Exchange Commission has also
required different financial structures, including banks and
other large-capitalization registrants, to quantify and report
their market-risk exposure with VaR disclosure being one measure
in order to comply. In 1993, Group of Thirty (G30) also endorsed
VaR as part of `best practices' for dealing with derivatives.
Spurred by all these developments, VaR has become a standard
measure of financial market risk that is increasingly used
by other financial and even non-financial firms as well. |
