I read a post on FT about Stressed out VaR which discussed one of the salient point in the Turner Review - shortcomings of Value at Risk (VaR) and potential of Stressed-out VaR. This prompted me to read the complete Turner Review. The review is accompanied by a discussion paper (Oops ... 219 pages long) which recommends several steps to enhance regulatory standards and supervisory.
In addition to the Stressed-Out Var (this is very interesting so please read the FT post as well as the related links), the problem of procyclicity with the Basel-II accord is also addressed.
In addition to the Stressed-Out Var (this is very interesting so please read the FT post as well as the related links), the problem of procyclicity with the Basel-II accord is also addressed.
The discussion paper says (Point 3.49) that
"In the FSA’s implementation a stress test reflecting an economic downturn such as might be experienced once in 25 years is employed, which is likely to be more stringent than that required by the Basel framework"
FSA recommends more stringent stress tests and it admits that (3.51) "recent experience of firms’ stress testing has been quite negative. Indeed, in many cases firms were over-optimistic about their ability to manage their capital effectively through a downturn"
The most important point according to my understanding was pointing out the procyclicity in the trading books. FSA says that "a fundamental review of the trading book is needed and must include consideration of the procyclicality of market risk capital requirements"
So far so good.
But the fundamental question is how to implement the recommendations and how to bring international community on a common platform. Famously, US did not agree to the recommended Basel-II accord and implemented its own version. The other question is how to standardize "more stringent stress tests" that FSA is recommending.
"In the FSA’s implementation a stress test reflecting an economic downturn such as might be experienced once in 25 years is employed, which is likely to be more stringent than that required by the Basel framework"
FSA recommends more stringent stress tests and it admits that (3.51) "recent experience of firms’ stress testing has been quite negative. Indeed, in many cases firms were over-optimistic about their ability to manage their capital effectively through a downturn"
The most important point according to my understanding was pointing out the procyclicity in the trading books. FSA says that "a fundamental review of the trading book is needed and must include consideration of the procyclicality of market risk capital requirements"
So far so good.
But the fundamental question is how to implement the recommendations and how to bring international community on a common platform. Famously, US did not agree to the recommended Basel-II accord and implemented its own version. The other question is how to standardize "more stringent stress tests" that FSA is recommending.
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