Michael McAleer, Econometric Institute, Erasmus University Rotterdam and Department of Applied Economics, National Chung Hsing University, Taiwan
Juan-Angel Jimenez-Martin, Department of Quantitative Economics, Complutense University of Madrid
Teodosio Pérez-Amaral, Department of Quantitative Economics, Complutense University of Madrid
In this paper we defined risk management in terms of choosing sensibly from a variety of conditional volatility (or risk) models, discussed the selection of optimal risk models, considered combining alternative risk models, choosing between a conservative and aggressive risk management strategy and evaluating the effects of the Basel II Accord on risk management. We also examined how risk management strategies performed during the 2008-09 financial crisis, evaluated how the financial crisis affected risk
management practices, forecasted VaR and daily capital charges, and discussed alternative policy recommendations, especially in light of the 2008-09 financial crisis. These issues were illustrated using Standard and Poor’s 500 Index, with an emphasis on how risk management practices were monitored and encouraged by the Basel II Accord regulations during the financial crisis.
Volatility has increased four-fold during the 2008-09 financial crisis, and remained relatively high after the crisis. This may be a reason why the financial crisis has changed the choice of risk management model for optimizing daily capital charges. Alternative risk models were found to be optimal before and during the financial crisis.
The area between the bounds provided by the aggressive and conservative risk management strategies would seem to be a fertile area for future research. A risk management strategy that used different combinations of alternative risk models for predicting VaR and minimizing daily capital charges was found to be optimal. A risk model that leads to the median forecast of VaR may also be a useful risk