A Conceptual Framework for Examining the Impact of Basel 2.5 on Market Risk Capital

Abstract

This study presents a conceptual framework that highlights the overreaching impact of Basel 2.5 on market risk capital. The Basel accords provide the basis for the calculation of the minimum capital that banks should maintain to fully absorb their credit, market, and operational risks. In Basel 2.5, the calculation of market risk capital is enhanced by the inclusion of stressed value-at-risk, a new metric designed to account for future periods of extreme market volatility.
As this study demonstrates, however, the use of this additional risk estimator often leads to the unintended consequence of excessive and costly capital charge, especially when the stressed period is overshadowed by more recent but less turbulent market events.