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THE CONSEQUENCES OF BASEL III REQUIREMENTS FOR LIQUIDITY HORIZON AND IT’S IMPLICATION ON OPTIMAL TRADING STRATEGY
- 46 страниц
- 2020 год
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Table of contents
Introduction. 3
Calculating the ES according to the Basel standards. 6
Literature review. 9
Methodology and data. 14
Results 26
Conclusion 41
Bibliography 42
Calculating the ES according to the Basel standards.
In this subsection, we present the methodology for calculating the ES outlined in Basel III and provide a simple example to give the basic idea of how the inclusion of the LH parameter affects the total ES. The minimum capital requirements for market risk were revised in January 14th, 2019, which replaced the earlier version from January 2016 and will come into effect on January 1st, 2022. The standards introduced some notable changes in terms of banks’ internal risk modelling but kept the old method of calculating expected shortfall intact. According to the standards, the banks have a discretion in terms of modelling their expected shortfall, but they also must fulfill the minimum requirements imposed by Basel III. The banks are required to use 97.
...
Literature review.
Our research covers wide range of topics, which can be summarized into three parts:
the research in the field of ES, optimal control, and liquidity horizon.
Regarding the first part, the topic of incorporating the LH directly into the calculation of the ES is not covered. The following papers address the methodology of ES computation in practice, the model risks, and the consequences of shifting from VaR to ES. The ES is a coherent risk measure (Artzner, et al. 2001) which makes it preferable to VaR, but according to Fissler and Ziegel (2019), it’s main drawback lies in its non-elicitability, meaning that it does not have a proper scoring (or loss) function used to rank different models by their prediction accuracy and hence, backtesting. But despite this drawback, the authors showed that ES is jointly elicitable with VaR, which is due to the strict elicitability of VaR itself. Based on these findings, Ziegel et.
...
Methodology and data.
Our model of determining the optimal liquidity horizon will be based on the model of Almgren and Chriss (2000). In their paper, Almgren and Chriss (2000) provided a two-sided approach for the problem of minimizing both execution uncertainty, which is unknown, and transaction costs, which are known to the trader. One of them centers around minimizing the implementation shortfall for a given variance:
min ( ) + ( )
(3)
≤ ∗
• where:
◦ E(x) is the expected implementation shortfall.
◦ V(x) is the variance of the implementation shortfall.
◦ x is the portion of holdings to be bought/sold at a fixed interval of time.
The implementation shortfall is the difference between the current value of the holdings and the actual proceeds from completely selling/buying off the portfolio:
̃
(4)
= 0−∑
• where:
◦ X is the total holdings position of the portfolio.
◦ S0 is the current market price of stocks.
...
Conclusion
In our thesis we presented a new formula-based approach to calculate optimal liquidity horizon (LH) for the purposes of scaling the base expected shortfall as outlined in Basel III Minimum Capital Requirements for Market Risk. Our research was in part, motivated by the absence of current researches in this topic, which left an open question of whether the current LH values recommended by the committee are reasonable enough to be employed in expected shortfall calculations. We employed the model of “half-life” from Almgren and Chriss (2000) to compute the LH values and defined an optimal expected shortfall (OES) measure. We then compared the OES to the current regulatory expected shortfall (RES) by means of regression-based ES backtesting, first proposed by Bayer, S., & Dimitriadis, T. (2018), on daily returns of SP500 and DJIA indices.
In the end, we obtained two interesting results.
...
Bibliography
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42
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