Subject Code : EFB344
EFB344 - Market Risk - Value At Risk - VaR Model - Risk Management Assessment Answer
Assessment Task:

Task

The task you are given is to estimate the market risk for a 5 year Commonwealth government bond, held on September 2, 2019 (you are working out the risk position assuming that you own the bond at the close of trading the previous day).  You will do this by estimating the Value-at-Risk for the bond.  This will require you to choose the best VaR model by backtesting several methods to determine the most reliable for the task at hand.

Based on what you have learnt from EFB344, you are considering several options for how to compute this risk measure,  

a) the normal distribution using the EWMA for volatility, or

b) a normal distribution based on a rolling window for volatility.  Both methods require choosing parameters to assign a weight to past data, λ for the EWMA and the window length for the rolling window.

This leaves you with two possible models that could be used to provide the VaR measure asked for above.  You must choose the most appropriate model and report the associated 10 days of VaR.  To inform your decision of which to use, you are going to consider the recent historical performance of both models in calculating 1 day VaR at the confidence level of 99%.  You will do so by first examining the frequency of instances when the VaR was exceeded by the observed loss over the period for which you are provided with historical data (approximately five years).

You will then evaluate the appropriateness of these frequencies over time relative to the Basel traffic light levels discussed in lectures. Based on this performance, select the best model and report 

Bond Pricing details and Risk management assumptions

The bond you are dealing with has five years to maturity, with semi-annual coupons at a rate of 4% per annum.  The face value of the bond is $1,000,000.  When pricing the bond you are to assume that you use a single discount rate for all cash flows (you are provided with data for this rate).  This is equivalent to assuming a flat yield curve that always moves in parallel shifts.

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  • Uploaded By : Mitchell Lee
  • Posted on : October 26th, 2018

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