Measuring Market Risk for Commercial Banks in the Volatile Environment of an Emerging Market Economy

Slovenian commercial banks have two possibilities for calculating capital charges for the market risks to which they are exposed. Due to the capital decree legislated by the Bank of Slovenia, they can use standardized methodology or apply an internal model. An internal model can be based on different risk measures, with each risk measure having its strengths and weaknesses. Consequently, the volume of risk calculated using a specific risk measure will vary among risk measures. Basel II regulation assumes VaR methodology for capital requirements calculations for the market risks to which commercial banks are exposed. There are two commonly used methods for VaR calculation - historical simulation and the variance-covariance method. Each has its strengths and weaknesses. The goal of this paper is to present the methodology of volatility and time weighted historical simulation as an internal model for market risk measurement in Slovenian commercial banks. The methodology is based on historical simulation and tries to remove the disadvantages of this method with GJR GARCH volatility modelling and the time weighting of returns.