CEBA talks 2020-2024
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Strategic Risk-Modelling by Banks: Evidence from Inside the Black Box

Authors: Mike Mariathasan, Ouarda Merrouche and Elizaveta Sizova

Abstract: This paper investigates the strategic use of banks’ internal models for market risk. We study hand- collected data on modelling and disclosure choices and examine how they relate to banks’ reported levels of Value-at-Risk (VaR) and the number of VaR violations. We show that more elaborate internal modelling can correspond to higher VaR and more VaR violations being therefore unambiguously more punitive for banks in terms of capital requirements. At the same time, such modelling can be also more opaque and fail to assess risk more precisely than theoretically more inferior modelling. We conclude that capital requirements for market risk are compromised by strategic modelling, and show how the degree of distortion depends on specific modelling choices.