6. The approach for identifying the appropriate historical period

In order to choose a historical period for calibration purposes, institutions should formulate a methodology for identifying a stressed period relevant to their current portfolios, based on one of the following two ways:

• i. judgement-based approaches; or
• ii. formulaic approaches.

A judgement-based approach is one that does not use a detailed quantitative analysis to identify the precise period to use for calibration, but rather relies on a high-level analysis of the risks inherent in an institution’s current portfolio and past periods of stress related to those risk factors. Where this judgement-based approach is used by institutions, it should include quantitative elements of analysis.

A formulaic approach instead is one that applies, in addition to expert judgement, a more systematic quantitative analysis to identify the historical period representing a significant stress for an institution’s current portfolio. This more systematic approach could be employed in a number of ways:

• i. A risk-factor based approach: an institution identifies a restricted number of risk factors which are considered to be a relevant proxy for the movement in value of its portfolio. The historical data for these risk factors can then be fully analysed to identify the most stressed period (for example, through identification of the period of highest volatility of the risk factors), in the historical data window.
• ii. A VaR based approach: the historical period is identified by running either the full VaR model or an approximation over a historical period to identify the 12-month period which produces the highest resulting measure for the current portfolio.

This approach should be employed to determine a historical period that would provide a conservative capital outcome rather than just selecting the period of highest volatility.

While either approach may be used by institutions, the use of the formulaic approach, where possible, should be preferred for the identification of the historical period.

Institutions may also combine the above two approaches to limit the computational burden of the formulaic approach. This can be done by using the judgement-based approach to restrict the historical data periods to be considered in the formulaic approach.

Irrespective of the approach used, institutions should provide evidence that the stressed period is relevant for their current portfolio and that they have considered a

10 range of potential historical periods in their analyses. The institutions should also have to prove that the portfolio on which the identification of the stressed periods is based is representative of the institutions’ current portfolio, e.g. by applying the approach to identify the stressed period to other typical or previous portfolios. As an example, for many portfolios, a 12-month period relating to significant losses in 2007/2008 would adequately reflect a period of such stress, but, in addition to that, other periods relevant to the current portfolio should also be considered by institutions.

In all cases no weighting of historical data should be applied when determining the relevant historical period or when calibrating the Stressed VaR model, as the weighting of data in a stressed period would not result in a true reflection of the potential stressed losses that could occur for an institution’s portfolio.

Finally, competent authorities may require institutions to use antithetic data when calibrating the Stressed VaR model, especially where an institution’s portfolio is characterized by frequent position changes.

7. Documentation to support the approach used to identify the stressed