Value at Risk: Issues and implementation in Forex market in India

Abstract

Value-at-Risk (VaR) has been widely promoted by the Bank for International Settlement (BIS) as well as central banks of all countries as a way of monitoring and managing market risk and as a basis for setting regulatory minimum capital standards. The revised Basle Accord, implemented in January 1998, makes it mandatory for banks to use VaR as a basis for determining the amount of regulatory capital adequate for covering market risk. Foreign exchange forms a major part of banks’ holding and hence are subject to risk. We have adopted three categories of VaR methods, viz., Variance-Covariance (Normal) methods including Risk-Metric, Historical Simulation (HS) and Tail-Index Based approach. We have used the daily exchange rate data from March 1, 1993 to October 8, 2003 for our analysis. Empirical results show that most of the models are failing in 1 500 rolling window while the full sample data is over estimating the VaR.