Article

Value-at-Risk Estimation of Foreign Asia-Pacific Journal of Management

Research and Innovation

Exchange Rate Risk in India

12(1) 1–10
© 2016 Asia-Pacific
Institute of Management
SAGE Publications
sagepub.in/home.nav
DOI: 10.1177/2319510X16650057
Onkar Shivraj Swami1 http://apjmri.sagepub.com

Santosh Kumar Pandey1

Puneet Pancholy1

Abstract
Banks are required to maintain an appropriate level of capital which must commensurate with the riskiness of their portfolio. Recently,
the Reserve Bank of India (RBI) issued a circular on Prudential Guidelines on Capital Adequacy—Implementation of Internal Models Approach
(IMA) for Market Risk to select a suitable method for the banks to determine the regulatory capital requirement under the market
risk exposure. Banks which adopt this approach are required to quantify market risk through their own Value-at-Risk (VaR) model.
Therefore, it is a challenging task for risk managers of the bank to select an appropriate risk model which reasonably covers the risk
of the bank’s portfolio. Use of wrongly calibrated risk models may lead to undercapitalised banking system. This article aims at
exploring the suitable risk model for measuring foreign exchange risk in banks’ portfolio. The objective of present study is to empirically
test the appropriate VaR model for foreign exchange rate risk. Value-at-Risk has been estimated for foreign exchange rate risk by
using parametric variance–covariance method and non-parametric historical simulation (HS) method. Under parametric method, VaR
is estimated by assuming that returns follow normal and Student’s t-distribution. Backtesting results for various VaR models have been
done based on Kupiec’s proportion of failures (KPOF) test and regulatory ‘traffic light’ test. This article concludes that when returns
are non-normal, VaR model based on the assumption of normality significantly underestimates the risk. Our empirical results based on
backtesting show that most accurate VaR estimates are obtained from Student’s t VaR model.

Keywords
Foreign exchange rate risk, internal models approach, Value-at-Risk, historical simulation, variance–covariance, VaR backtesting

Introduction economic (operational, competitive or cash flow) and trans-

According to the Basel Committee on Banking Supervision
(BCBS), market risk is defined as ‘the risk of losses in on
and off-balance-sheet positions arising from movements in
market prices’ (BIS, 2005). Market risk is the risk of losses
to the bank arising from movements in market prices as a
result of changes in interest rates, foreign exchange rates
and equity and commodity prices.
Foreign exchange rate risk is the risk that the value of
the bank’s assets or liabilities changes due to currency ex-
change rate fluctuations. By buying and selling the foreign
exchange on behalf of their customers, banks are exposed to
exchange rate risk. Generally, banks are vulnerable to three
types of foreign exchange risk: transaction (commitment),
lation (accounting) (Abor, 2005). Transaction risk arises
when the value of existing obligations is deteriorated
by movements in foreign exchange rates (Abor, 2005).
Economic risk occurs due to impact of high unexpected
volatility in the exchange rate on equity/income for both
domestic and foreign operations. Translation risk is associ-
ated with the assets or income derived from offshore
activities (Abor, 2005).
BCBS has adopted VaR as a primary measure of market
risk for determining the bank capital adequacy (BCBS,
2006). Subsequently, VaR has become the standard measure
for estimating the market risk in financial sector industries.
Value-at-Risk is defined as ‘the worst loss over a target
horizon with a given level of confidence’ (Jorion, 2007).

Disclaimer: The views expressed in this study are of the authors and not of the institution to which they belong.

1  Banking Policy Division, Department of Banking Regulation, Central Office, Reserve Bank of India, Shahid Bhagat Singh Marg, Fort, Mumbai, Maharashtra,

India.

Corresponding author:
Onkar Shivraj Swami, Banking Policy Division, Department of Banking Regulation, Reserve Bank of India, Shahid Bhagat Singh Marg, Fort, Mumbai
400001, India.
E-mail: oswami@rbi.org.in
2 Asia-Pacific Journal of Management Research and Innovation 12(1)
The portfolio VaR estimates the maximum loss with the
given probability an investor may suffer over a given time
period (Abad, Benito & López, 2014).
The objective of the present study is to empirically test
the foreign exchange rate risk for the management of
market risk with the use of VaR methodology. Value-at-
Risk has been estimated for foreign exchange rate risk by
using (i) parametric method called as variance–covariance
approach and (ii) non-parametric HS method.
The article is organised as follows. In the next section,
we review HS and parametric approach to estimate the
VaR. The third section provides the regulatory framework
for market risk in India. The fourth section delineates
topics related to data and methodology. Empirical findings
are given in the fifth section. The last section concludes the
findings of the study.
Theoretical Background,
Concept and Definitions
Definition and Concept of VaR
Value-at-Risk is a statistical measure that summarises
all the risks of a portfolio into a single number suitable
for use in the boardroom, for reporting to regulators or for
disclosure in an annual report. More precisely, according
to Elliott and Miao (2009), ‘VaR is a statistical estimate of
a portfolio loss with the property that, with a small pro-
bability α, the owner of the portfolio stands to incur that
loss or moreover a given (typically short) holding period.’
In general, a may be fixed at 1, 2.5 and 5 per cent and the
holding period may be taken as 1, 2 and 10 business days
or 1 month.
According to Jorion (2007), ‘VaR is the worst loss over
a target horizon such that there is a low, prespecified
probability that the actual loss will be larger.’ This definition
consists of two parameters: the risk horizon and the
confidence level. Let a be the confidence level and L be
the loss, measured as a positive number. Value-at-Risk is
also reported as a positive number (Jorion, 2007). Again
as mentioned by Jorion (2007), a general definition of
VaR is that it is the smallest loss, in absolute value, such
that
P [L > VaR] # 1 – a
Take, for example, a 99 per cent confidence level
(i.e., a = 0.99). Value-at-Risk then is the cut-off loss such
that the probability of experiencing a greater loss is less
than 1 per cent. Jorion (2007) also has suggested that the
length of time required to hedge the market risk should be
in alignment with the risk horizon. It is convenient to use
short risk horizons than the longer one for the frequently
trading portfolios such as foreign exchange rates (Sirr,
Garvey & Gallagher, 2011).
VaR Models
The non-parametric HS method and parametric method
for estimating the VaR, that is, variance–covariance
approach, are described below:
Historical Simulation Method
The historical VaR model assumes that all possible future
variations have been experienced in the past, and that
the historically simulated distribution is identical to the
returns distribution over the forward-looking risk horizon
(Alexander, 2008a, 2008b). Thus, non-parametric HS has
some advantages over the parametric method, as it makes
no assumption about the shape of the distribution of returns.
Further, HS method is very easy to implement. However,
more recent studies (Abad et al., 2014; Angelidis, Benos
& Degiannakis, 2007; Ashley & Randal, 2009; Trenca,
2009) have mentioned that the HS method gives poor VaR
estimates. Filtered HS and conditional extreme value
provide more adequate VaR estimates than HS VaR (Abad
et al., 2014). Nevertheless, by far HS approach is most
widely implemented by the banks for estimating the daily
VaR (Pérignon & Daniel, 2010).
Parametric Method
Wang, Wu, Chen and Zhou (2010) mentioned that the
variance–covariance method is a parametric method to
calculate VaR. This parametric method needs the estimation
of standard deviation of the portfolio by means of sample
estimation of variance (Rossignolo, Duygun & Mohamed,
2012). The 100a per cent h-day normal linear VaR for
single exchange rate is given by
VaR h, a = U -1 (1 – a) v h
where vh is the standard deviation of the sample returns
and U –1 (1 – a) is the inverse of the cumulative density
function of the standard normal distribution.
Similarly, 100a per cent h-day normal linear VaR for
portfolio of foreign exchange rates is given by
VaR h, a = U –1 (1 – a) wl Vh w – wl E (X h)
where risk factor returns are multivariate normal and
independent and identically distributed (iid), w denotes the
current vector of portfolio weights, E(Xh) is the n × 1
vector of the expected/mean excess h-day returns and Vh is
the h-day covariance matrix of foreign exchange rates
return.
To estimate the VaR with high peaks and heavy tails
of exchange rate returns, it is ideal to assume that U(·)
Swami et al. 3
follows Student’s t-distribution (Wang et al., 2010). When
h is small, an approximate formula for the 100a per cent
h-day Student’s t VaR is given by
Student t VaR h, a, y = y -1 (y - 2) ht y-1 (1 – a) v – hn
where y denotes degrees of freedom for Student’s t-
distribution.
Similarly, 100a per cent h-day Student’s t VaR for
foreign exchange rates portfolio is given by
Student t VaR h, a, = y -1 (y - 2) ht -y 1 #
 approach, for portfolios other than linear portfolios
(1 – a) il X h i – il n h)
where Xh denotes the m × m covariance matrix of the risk
factor and nh denotes the m × 1 vector of expected/mean
excess returns over the h-day risk horizon.
Regulatory Framework
To allocate adequate regulatory capital under the market
risk, Basel II framework on capital adequacy provides
two methods, namely, standardised measurement method
(SMM) and Internal Models Approach (IMA). Since 31
March 2005, banks in India have been measuring market
risk under Basel II accord by using the SMM. Compared to
the SMM, the IMA is considered to be more risk sensitive
and aligns the capital charge for market risk more closely
to the actual losses likely to be incurred by banks due to
movements in the market risk factors. Therefore, the
Reserve Bank of India (RBI) issued circular on Prudential
Guidelines on Capital Adequacy—Implementation of
Internal Models (IMA) Approach for Market Risk on 7
April 2010 to provide a wider choice to banks in select-
ing a method for determining the regulatory capital require-
ment for their market risk exposure (RBI, 2010). As of
now, none of the banks in India are determining the regula-
tory capital requirement for their market risk exposure by
using IMA.
VaR
As per the RBI’s circular on Prudential Guidelines on
Capital Adequacy—Implementation of Internal Models
(IMA) Approach for Market Risk issued on 7 April 2010,
the capital requirement is a function of three components:
‘(1) Normal VaR Measure (for general market risk and
specific risk) (2) Stressed VaR Measure (for general market
risk and specific risk) and (3) Incremental Risk Charge
(IRC) (for positions subject to interest rate specific-risk
capital charge)’. Further, according to the same circular on
IMA dated 7 April 2010, mandatory parameters for VaR
models are given below:
1. Value-at-Risk must be computed on a daily basis.
2. In calculating VaR, a 99th percentile, one-tailed
confidence interval is to be used.
3. In calculating VaR, an instantaneous price shock
equivalent to a 10-movement in prices is to be
used, that is, the minimum ‘holding period’ will
be 10 trading days. Banks may use VaR numbers
calculated according to shorter holding periods
scaled up to 10 days in an appropriate manner. Banks
should use the ‘square root of time rule’ only for
linear portfolios with identically and independently
normally distributed returns. A bank using this
with identically and independently normally distri-
buted returns, must periodically justify the reasona-
bleness of its approach to the satisfaction of the RBI.
For calculating VaR, it is essential to have a minimum,
past 1 year daily returns data (i.e., 250 trading days). Banks
in India are permitted to use any VaR model subject to
the condition that it is satisfies the above requirements, that
is, variance–covariance matrices, HSs, etc., for calculating
the VaR under the market risk exposure.
Regulatory Backtesting
Rossignolo et al. (2012) mentioned that ‘backtesting
constitutes a statistical technique to assess the quality of
the risk measurement specifications which involves the
comparison between the daily VaR forecast with the actual
losses’. Backtesting involves comparing the number of
times actual losses exceed VaR estimates in approximately
250 trading days (Rossignolo et al., 2012). In accordance
with Basel II requirements, the RBI under IMA guide-
line (2010) has stated that ‘backtesting will be based on
1 percent daily VaR estimate i.e. holding period is assumed
as one day and it will cover a period of 250 days’. For
backtesting, most recent 12 months of data (i.e., 250 daily
observations) are used. Apart from backtesting VaR model
based on 1 per cent VaR, banks can validate model
assumptions at 2, 5 and 10 per cent VaR. In general, to have
one exception in a month (1 in 20 trading days) for
backtesting, 95 per cent confidence level is considered to
be more appropriate.
As per RBI’s circular on IMA dated 7 April 2010,
backtesting outcomes can be classified into three zones
depending on the number of exceptions coming out of
the backtesting, often called the ‘traffic light’ approach.
Based on the number of exceptions, backtesting outcomes
will fall in either green zone, yellow zone or red zone
and the corresponding zone-wise increase in the multi-
plication factors for both VaR and stressed VaR are given
in Table 1.
4 Asia-Pacific Journal of Management Research and Innovation 12(1)

Table 1. Zone-wise Classification Backtesting Outcomes this study calculates VaR with 99 per cent confidence
level for 1-day horizon. First, we estimate 1-day VaR for
Number of Increase in
3 January 2000, that is, 251st day by using the entire returns
Zone Exception Multiplication Factor
of the year 1999 (i.e., around 250 days observations).
Green zone 0 0.00 Second, we calculate VaR for 4 January 2000, that is,
1 0.00 252nd day using returns from 5 January 1999 to 3 January
2 0.00 2000. In a similar way, VaR is estimated up to the last data
3 0.00 point of the present study (i.e., 31 December 2013). We
have used 1-year data, that is, about 250 days data rolling
4 0.00
window, for our VaR analysis and backtesting.
Yellow zone 5 0.40 Although it is computationally convenient to assume
6 0.50 normal distribution of the returns when calculating the
7 0.65 VaR, it always does not hold true. Estimation based on
8 0.75 normal distribution produces significant errors when
dealing with skewed data. We have used Q–Q plots and
9 0.85
Jarque–Berra test for detecting the non-normality.
Red zone 10 or more 1.00 Value-at-Risk violation occurs when returns exceed the
Source: Reserve Bank of India. estimated VaR. Backtesting is a statistical procedure in
which actual returns are systematically compared to corres-
ponding VaR estimates. The backtesting of estimated VaR
Methodology is carried out for each year from 2000 to 2013 by using the
The main data contain univariate price series of three latest preceding 1-year data (i.e., about 250 days). In addi-
foreign exchange currencies, that is, Indian rupee (INR)/ tion to regulatory backtesting, we have also performed
US Dollar (USD), INR/POUND and INR/EUR. We have backtesting using KPOF test (Kupiec, 1995). Kupiec’s test
taken a hypothetical portfolio of 200 million INR. Of these, measures whether the number of exceptions is consistent
100 million INR foreign exchange business of a bank is in with the confidence level (Nieppola, 2009).
USD, 50 million INR business is in pound sterling and
euro each (i.e., INR/USD has 50 per cent weight of total
portfolio, and INR/POUND and INR/EUR each have Results
25 per cent weight in total portfolio). The data are retrieved
from RBI’s database on Indian economy for the period Descriptive Statistics
from 4 January 1999 to 31 December 2013. The descriptive statistics of daily logarithmic returns of the
The daily logarithmic return Rt is defined as three series and portfolio are given in Table 2. For all the
Pt
Rt = ln d n . For each exchange rate, we have 3,400 three series, skewnesses of daily logarithmic returns are
Pt–1 not equal to zero and kurtosises are greater than three.
daily logarithmic returns. As per regulatory requirements, Further, portfolio reruns series also has skewness greater

Table 2. Descriptive Statistics of Daily Logarithmic Return from Three Exchange Rates of INR

Parameters INR/USD INR/POUND INR/EUR Portfolio

Mean 0.00010 0.00010 0.00014 0.00011
Median 0.00000 0.00020 0.00020 0.00010
Minimum –0.03010 –0.05700 –0.03890 –0.03180
Maximum 0.04020 0.03680 0.04150 0.03970
Standard deviation 0.00432 0.00632 0.00680 0.00429
Skewness 0.26790 –0.41229 –0.02087 0.22510
Kurtosis 11.39130 7.86258 5.09643 9.50848
Jarque–Bera 10,723 3,689 667 6,455
Probability 0.00000 0.00000 0.00000 0.00000
N (sample size) 3,640 3,640 3,640 3,640
Source: Authors’ calculation.
Swami et al. 5

than zero and kurtosises greater than three (Table 2). This
suggests that these exchange rate series and portfolio
returns do not follow the normal distribution. These find-
ings are also supported by the Jarque–Bera statistics for
daily logarithmic returns of the three series and portfolio.
Figure 1 depicts the histogram of daily logarithmic return
for three exchange rates of INR and portfolio returns. From
these histograms, it appears that all three series and portfo-
lio returns have high peak than normal distribution. In
general, Q–Q plot is used to identify the distribution of
sample in the study. Figure 2 represents the Q–Q plot
of daily logarithmic return for three exchange rates of

Figure 1. Histogram of Daily Logarithmic Return from Three Exchange Rates of INR and Portfolio Returns
Source: Authors’ calculation.
6 Asia-Pacific Journal of Management Research and Innovation 12(1)

Figure 2. Q–Q Plot of Daily Logarithmic Return from Three Exchange Rates of INR and Portfolio Returns
Source: Authors’ calculation.

INR and portfolio returns. The Q–Q plot compares the dis-
tribution for each exchange rate returns including portfolio
returns with the normal distribution and indicates that all
three exchange rates of INR and portfolio returns deviate
from the normal distribution.
VaR
Figure 3 shows the time series of portfolio of foreign
exchange rate returns. The logarithmic returns and VaR
based on HS and normal and Student’s t-distribution are
Swami et al. 7
Figure 3. Graph of Daily Portfolio Returns and VaR Estimated by Using Various Models
Source: Authors’ calculation.
estimated on a daily basis. The time series begins on 3
January 2000 as the previous 1-year data (i.e., year 1999)
are needed to estimate the initial parameters. The chart
shows the significant increase in volatility of foreign
exchange rate portfolio returns from the second half of
2008 and as a result, VaR estimates also worsen.
Daily estimated HS_VaR has been highest between the
period December 2008 and November 2009. In fact, HS_
VaR estimates are higher than VaR estimates based on
normal and Student’s t-distribution for the same period.
This is the period when the Global Financial Crisis (GFC)
began. As the foreign exchange rate returns are non-
normal, Normal_VaR estimates underestimate the risk
throughout the study period. Moreover, as GFC progressed
further, Normal_VaR has performed even more poorly.
This confirms the belief that as return distributions do not
follow normal distribution, risk estimates based on assump-
tion of normality will not provide robust risk assessments.
It is therefore prudent for banks and bank supervisors to
look into the assumptions of return distribution while
computing regulatory capital based on their internal risk
models. When significant positive excess kurtosis is found
in empirical return distribution, the Student’s t-distribution
is likely to produce VaR estimates that are more close to
historical behaviour than normal distribution (Elliott &
Miao, 2009; Lin & Shen, 2006). The Student’s t-distribution
is more adequate to deal with the fat-tailed and leptokurtic
features. As our foreign exchange rate returns are having
leptokurtic feature, the VaR estimates based on Student’s
t-distribution appear to be more appropriate. From Figure 3,
in general, it seems that VaR estimates based on Student’s
t-distribution lie between the estimates based on HS_VaR
and Normal_VaR. During the GFC onset and the later
period, the Student’s t VaR has performed better than
Normal_VaR.
Backtesting of VaR Models
Value-at-Risk violation occurs when actual portfolio loss
exceeds the estimated VaR. Tables 3–5 represent the
backtesting results for various VaR models based on KPOF
test and regulatory ‘traffic light’ test. We have observed 59
exceptions/violations for HS_VaR model over the study
period, that is, from 2000 to 2013. For HS_VaR model, the
maximum number of violations occurred in the year 2008
followed by the year 2007 and 2013. Backtesting based
on KPOF test for HS_VaR model is accepted for 11 years
(p ≤ 0.05) and is rejected for the years 2007, 2008 and 2013
(Table 3). Backtesting based on Regulatory test for HS_
VaR model has indicated a result in the red zone for the
year 2008 and yellow zone for the year 2003, 2007, 2012
and 2013.
For Normal_VaR model, we have observed 68 excep-
tions/violations over the study period. For Normal_VaR
model, the maximum number of violations occurred dur-
ing the years 2007 and 2008. Form Figure 3, it is clear
that throughout the study period, VaR number based on
Normal_VaR model is underestimated. Backtesting based
on KPOF test for Normal_VaR model is accepted for 11
years (p ≤ 0.05) and is rejected for the years 2004, 2007and
2008. Backtesting based on regulatory test for Normal_
VaR model has indicated a result in the red zone for the
years 2007 and 2008 and yellow zone for the years 2000,
2004 and 2013.
8 Asia-Pacific Journal of Management Research and Innovation 12(1)

Table 3. Backtesting of HS_VaR Model

No. of Percentage of Kupiec’s Proportion of Failures Test

Year Exceptions No. of Exceptions Likelihood Ratio Accept/Reject Regulatory Test
2000 4 1.6 0.77 Accept Green zone
2001 2 0.8 0.11 Accept Green zone
2002 1 0.4 1.18 Accept Green zone
2003 5 2 1.96 Accept Yellow zone
2004 4 1.6 0.77 Accept Green zone
2005 2 0.8 0.11 Accept Green zone
2006 2 0.8 0.11 Accept Green zone
2007 9 3.6 10.23 Reject Yellow zone
2008 10 4.0 12.96 Reject Red zone
2009 1 0.4 1.18 Accept Green zone
2010 3 1.2 0.09 Accept Green zone
2011 4 1.6 0.77 Accept Green zone
2012 5 2 1.96 Accept Yellow zone
2013 7 2.8 5.50 Reject Yellow zone
Source: Authors’ calculation.

Table 4. Backtesting of Normal VaR Model

No. of Percentage of Kupiec’s Proportion of Failures Test

Year Exceptions No. of Exceptions Likelihood Ratio Accept/Reject Regulatory Test
2000 5 2.0 1.96 Accept Yellow zone
2001 1 0.4 1.18 Accept Green zone
2002 1 0.4 1.18 Accept Green zone
2003 3 1.2 0.09 Accept Green zone
2004 8 3.2 7.73 Reject Yellow zone
2005 2 0.8 0.11 Accept Green zone
2006 2 0.8 0.11 Accept Green zone
2007 14 5.6 25.78 Reject Red zone
2008 14 5.6 25.78 Reject Red zone
2009 1 0.4 1.18 Accept Green zone
2010 3 1.2 0.09 Accept Green zone
2011 4 1.6 0.77 Accept Green zone
2012 4 1.6 0.77 Accept Green zone
2013 6 2.4 3.56 Accept Yellow zone
Source: Authors’ calculation.

We have observed 43 exceptions/violations for t_VaR
model over the study period. For t_VaR model, the maxi-
mum number of violations occurred during the year 2007.
Backtesting based on KPOF test for t_VaR model is
accepted for all years (p ≤ 0.05) except for the year 2007.
Backtesting based on regulatory test for t_VaR model has
indicated a result in the red zone for the year 2007 and
yellow zone for the years 2004 and 2008.
In general, VaR estimates based on normal distri-
bution have underestimated the VaR numbers. Among
the three models, Student’s t VaR model has performed
better. Intuitively, the parametric standard deviation-based
Swami et al. 9

Table 5. Backtesting of Student’s t VaR Model

No. of Percentage of Kupiec’s Proportion of Failures Test

Year Exceptions No. of Exceptions Likelihood Ratio Accept/Reject Regulatory Test
2000 1 0.4 1.1765 Accept Green zone
2001 1 0.4 1.1765 Accept Green zone
2002 1 0.4 1.1765 Accept Green zone
2003 3 1.2 0.0949 Accept Green zone
2004 6 2.4 3.5554 Accept Yellow zone
2005 2 0.8 0.1084 Accept Green zone
2006 1 0.4 1.1765 Accept Green zone
2007 12 4.8 19.0162 Reject Red zone
2008 6 2.4 3.5554 Accept Yellow zone
2009 1 0.4 1.1765 Accept Green zone
2010 2 0.8 0.1084 Accept Green zone
2011 4 1.6 0.7691 Accept Green zone
2012 1 0.4 1.1765 Accept Green zone
2013 2 0.8 0.1084 Accept Green zone
Source: Authors’ calculation.

approach should be more precise. Indeed, estimates of
standard deviation use information about whole distribu-
tion, whereas quantile uses only the ranking of observa-
tions and the two observations around the estimated value,
that is, parametric methods are inherently more precise
because the sample standard deviation contains far more
information than sample quantiles (Jorion, 2007).
Conclusion
In this empirical study, we have applied various models/
methods for estimating VaR for the portfolio of foreign
exchange currencies. Value-at-Risk has been estimated
for foreign exchange rate risk by using variance–covariance
approach and non-parametric HS method. For estimat-
ing the VaR based on various models, we have followed
the regulatory framework by RBI on Prudential Guidelines
on Capital Adequacy—Implementation of Internal Models
Approach for Market Risk in India (RBI, 2007).
Estimation of VaR would be made simply by using
mean and standard deviation of the return distribution if
returns are normally distributed. But the financial market
returns usually do not follow normal distribution. The
returns in our study are leptokurtic in nature. This observed
non-normality of returns should be handled suitably while
estimating VaR. Accordingly, we employed non-normal
VaR models, such as HS and Student’s t VaR model.
Our empirical results based on backtesting show that
the VaR estimates based on the conventional ‘normal’
method are usually underestimated (lower than actual).
Interestingly, HS method has performed better than
Normal_VaR model. However, most accurate VaR esti-
mates are obtained from Student’s t VaR model.
Acknowledgements
We are extremely grateful to Sudarshan Sen, Principal Chief
General Manager, Department of Banking Regulation, Reserve
Bank of India, Mumbai, for his constant guidance and support
in the preparation of this article. Further, helpful discussion and
suggestions from Madhusmita Dutta, Manager, Foreign Exchange
Department, Reserve Bank of India, Mumbai, for improving the
article are highly acknowledged.
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