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An extreme value theory approach to calculating minimum capital risk requirements

Brooks, C., Clare, A.D. and Persand, G. (2002) An extreme value theory approach to calculating minimum capital risk requirements. Journal of Risk Finance, 3 (2). pp. 22-33. ISSN 1526-5943

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To link to this item DOI: 10.1108/eb043485


This paper investigates the frequency of extreme events for three LIFFE futures contracts for the calculation of minimum capital risk requirements (MCRRs). We propose a semiparametric approach where the tails are modelled by the Generalized Pareto Distribution and smaller risks are captured by the empirical distribution function. We compare the capital requirements form this approach with those calculated from the unconditional density and from a conditional density - a GARCH(1,1) model. Our primary finding is that both in-sample and for a hold-out sample, our extreme value approach yields superior results than either of the other two models which do not explicitly model the tails of the return distribution. Since the use of these internal models will be permitted under the EC-CAD II, they could be widely adopted in the near future for determining capital adequacies. Hence, close scrutiny of competing models is required to avoid a potentially costly misallocation capital resources while at the same time ensuring the safety of the financial system.

Item Type:Article
Divisions:Henley Business School > ICMA Centre
ID Code:24159
Uncontrolled Keywords:Minimum Capital Risk Requirements, Generalized Pareto Distribution, GARCH models
Publisher Statement:This article is (c) Emerald Group Publishing and permission has been granted for this version to appear here ( Emerald does not grant permission for this article to be further copied/distributed or hosted elsewhere without the express permission from Emerald Group Publishing Limited. The definitive version can be found at


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