Estimation of capital by price risk: evaluating methodologies for the Peruvian case

The Superintendency of Banking, Insurance, and Pension Fund Administrators (Superintendencia de Banca, Seguros y AFP) recently published regulations on capital requirements for market risk with the aim of bringing Peruvian legislation into line with international standards and the Basel Committee on Banking Supervision. This regulation requires financial institutions to calculate capital using one of two methods: the Standardized Approach provided by the regulator, or internal models for estimating Value at Risk developed by the institutions themselves. This paper evaluates three methods for calculating capital: the Standardized Approach and two internal model alternatives, one based on the RiskMetrics™ method and the other based on the CAIRVaR method. It compares the capital adequacy achieved by each method across a series of benchmark portfolios composed of Peruvian stocks, classified according to different ranges of market capitalization and trading volume. In particular, the effectiveness of each method is evaluated by considering the stress period from August through the end of 2008 following the collapse of Lehman Brothers. (Audio: Department of Economic Publications)