Message-ID: <30875629.1075863436568.JavaMail.evans@thyme> Date: Thu, 9 Aug 2001 15:07:56 -0700 (PDT) From: j.kaminski@enron.com To: j_martin@baylor.edu Subject: RE: Have you seen this? Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: Kaminski, Vince J X-To: '"John D. Martin" @ENRON' X-cc: X-bcc: X-Folder: \VKAMINS (Non-Privileged)\Kaminski, Vince J\Sent Items X-Origin: Kaminski-V X-FileName: VKAMINS (Non-Privileged).pst Hello John, Thanks for the lead. I have seen other papers on this topic. Vince -----Original Message----- From: "John D. Martin" @ENRON [mailto:IMCEANOTES-+22John+20D+2E+20Martin+22+20+3CJ+5FMartin+40baylor+2Eedu+3E+40ENRON@ENRON.com] Sent: Thursday, August 09, 2001 9:01 AM To: Kaminski, Vince J Subject: Have you seen this? "Incorporating Event Risk into Value-at-Risk" BY: MICHAEL S. GIBSON Board of Governors of the Federal Reserve System Division of Research and Statistics Document: Available from the SSRN Electronic Paper Collection: http://papers.ssrn.com/paper.taf?abstract_id=268849 Other Electronic Document Delivery: http://www.federalreserve.gov/pubs/workingpapers.htm SSRN only offers technical support for papers downloaded from the SSRN Electronic Paper Collection location. When URLs wrap, you must copy and paste them into your browser eliminating all spaces. Paper ID: FEDS Discussion Paper No. 2001-17 Date: February 2001 Contact: MICHAEL S. GIBSON Email: Mailto:michael.s.gibson@frb.gov Postal: Board of Governors of the Federal Reserve System Division of Research and Statistics Mail Stop 91 20th and Constitution Avenue NW Washington, DC 20551 USA Phone: 1-202-452-2495 Fax: 1-202-452-6424 Paper Requests: Please indicate the title and the FEDS paper number. Single copies of FEDS papers may be obtained upon request from Ms. Karen Blackwell, Mailto:fedspapers@frb.gov Postal: Mail Stop 77, Federal Reserve Board, Washington, DC 20551. Phone:(202) 452-2900. Fax:(202) 452-3819. ABSTRACT: Event risk is the risk that a portfolio's value can be affected by large jumps in market prices. Event risk is synonymous with "fat tails" or "jump risk". Event risk is one component of "specific risk", defined by bank supervisors as the component of market risk not driven by market-wide shocks. Standard Value-at-Risk (VaR) models used by banks to measure market risk do not do a good job of capturing event risk. In this paper, I discuss the issues involved in incorporating event risk into VaR. To illustrate these issues, I develop a VaR model that incorporates event risk, which I call the Jump-VaR model. The Jump-VaR model uses any standard VaR model to handle "ordinary" price fluctuations and grafts on a simple model of price jumps. The effect is to "fatten" the tails of the distribution of portfolio returns that is used to estimate VaR, thus increasing VaR. I note that regulatory capital could rise or fall when jumps are added, since the increase in VaR would be offset by a decline in the regulatory capital multiplier on specific risk from 4 to 3. In an empirical application, I use the Jump-VaR model to compute VaR for two equity portfolios. I note that, in practice, special attention must be paid to the issues of correlated jumps and double-counting of jumps. As expected, the estimates of VaR increase when jumps are added. In some cases, the increases are substantial. As expected, VaR increases by more for the portfolio with more specific risk. Keywords: Specific risk, market risk, jump risk, jump diffusion, default risk JEL Classification: G10, G28 John D. Martin Carr P. Collins Chair in Finance Finance Department Baylor University PO Box 98004 Waco, TX 76798 254-710-4473 (Office) 254-710-1092 (Fax) J_Martin@Baylor.edu web: http://hsb.baylor.edu/html/martinj/home.html