11. Estimation of proxies for Stressed VaR

Given that the data constraints that make necessary the use of proxies for VaR, become even more relevant for Stressed VaR and that it is expected that any proxies used in VaR will also be necessary for Stressed VaR, while additional ones may also be needed, whereas any new risk factor not present in the historical data should naturally require the use of a proxy for VaR calculation, but only on a ‘temporary’ basis (e.g. after one year there would be enough real information to complete a 12-month data series),the same proxy should be more ‘permanent’ for Stressed VaR purposes (due to the more constant nature of the historical time series).

If a risk factor is missing in the stressed period because it was not observable during that period (for example for a newly listed equity) the institution may use another risk factor (in this example, another equity from the same sector and with a similar risk and business profile) for which there is information available and for which a highly correlated behaviour with the factor that the institution is trying to capture can be demonstrated. Where these proxies are used, institutions should consider whether an assumption of 100% correlation between the risk factor and its proxy is appropriate.

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Institutions may alternatively map the missing factor to another one similar in terms of volatility (though not necessarily correlated). If this approach is used, institutions should demonstrate that it is conservative and appropriate.

If a VaR model is enhanced by incorporating a risk factor, an institution should also incorporate it into its Stressed VaR calculations. In certain cases, this may mean reviewing the historical data series for the risk factors and introducing an appropriate proxy. For example where a new risk factor used for valuation purposes is incorporated into the VaR model as required under Annex V point 12 first Paragraph of Directive 2006/49/EC as amended by Directive 2010/76/EU.

In all cases, the use of these proxies, including simplifications and any omissions made, will only be acceptable provided they are well documented and their limitations are taken into account and addressed in the institution’s capital assessment.