1.9 History of Value-at-Risk

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1.9 History of Value-at-Risk

The term “value-at-risk” (VaR) did not enter the financial lexicon until the early 1990s, but the origins of value-at-risk measures go further back. These can be traced to capital requirements for US securities firms of the early 20th century, starting with an informal capital test the New York Stock Exchange (NYSE) first applied to member firms around 1922.

1.9.1 Regulatory Value-at-Risk Measures

The original NYSE rule[1] required firms to hold capital equal to 10% of assets comprising proprietary positions and customer receivables. By 1929, this had developed into a requirement that firms hold capital equal to:

  • 5% of customer debits;
  • 10% (minimum) on proprietary holdings in government or municipal bonds;
  • 30% on proprietary holdings in other liquid securities; and
  • 100% on proprietary holdings in all other securities.

Over time, regulators took over responsibility for setting capital requirements. In 1975, the US Securities and Exchange Commission (SEC) established a Uniform Net Capital Rule (UNCR) for US broker-dealers trading non-exempt securities. This included a system of “haircuts” that were applied to a firm’s capital as a safeguard against market losses that might arise during the time it would take to liquidate positions. Financial assets were divided into 12 categories such as government debt, corporate debt, convertible securities, and preferred stock. Some of these were further broken down into subcategories primarily according to maturity. To reflect hedging effects, long and short positions were netted within subcategories, but only limited netting was permitted across subcategories. An additional haircut was applied to any concentrated position in a single asset.

Volatility in US interest rates motivated the SEC to update these haircuts in 1980. The new haircuts were based upon a statistical analysis of historical market data. They were intended to reflect a .95-quantile of the amount of money a firm might lose over a one-month liquidation period.[2] Although it would not have been called such at the time, this was a value-at-risk metric. The SEC’s calculation for haircuts was a value-at-risk measure.

Later, additional regulatory value-at-risk measures were implemented for banks or securities firms, including:

  • the UK Securities and Futures Authority 1992 “portfolio” value-at-risk measure;
  • Europe’s 1993 Capital Adequacy Directive (CAD) “building-block” value-at-risk measure; and
  • the Basel Committee’s 1996 value-at-risk measure based largely upon the CAD building-block measure.[3]

In 1996; the Basel Committee approved the limited use of proprietary value-at-risk measures for calculating the market risk component of bank capital requirements. In this and other ways, regulatory initiatives helped motivate the development of proprietary value-at-risk measures.

Footnotes    (↵ returns to text)
  1. See Dale (1996) pp. 60 – 61 and Molinari and Kibler (1983) footnote 41.
  2. See Dale (1996), p. 78.
  3. The Basel Committee on Banking Supervision is a standing committee comprising representatives from central banks and regulatory authorities. Over time, the focus of the committee has evolved, embracing initiatives designed to define roles of regulators in cross-jurisdictional situations; ensure that international banks or bank holding companies do not escape comprehensive supervision by some “home” regulatory authority; and promote uniform capital requirements so banks from different countries may compete with one another on a “level playing field.” Although the Basel Committee’s recommendations do not themselves have force of law, G-10 countries have a generally good track record of implementing those recommendations as statutes or regulations.
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3 Responses to 1.9 History of Value-at-Risk

  1. Andrew Janke at #

    Should “Basle Committee” be “Basel Committee” here?

    • Hi Andrew: Thanks for commenting.

      The Basel Committee is named, of course, for Basel, Switzerland, where it is based. “Basle” is an English spelling that was common but has mostly fallen out of use, much as “Peking” has fallen out of use. Up until Basel II, the committee consistently spelled its name “Basle Committee” and then switched to exclusively use “Basel Committee”.

      I have updated the spelling on this page.

      • Andrew Janke at #

        Interesting! I didn’t know that.

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