Lambda Value at Risk and Regulatory Capital : A Dynamic Approach to Tail Risk

This paper presents the first methodological proposal of estimation of the Lambda VaR. Our approach is dynamic and calibrated to market extreme scenarios, incorporating the need of regulators and financial institutions in more sensitive risk measures. We also propose a simple backtesting methodology by extending the VaR hypothesis-testing framework. Hence, we test our Lambda VaR proposals under extreme downward scenarios of the financial crisis and different assumptions on the profit and loss distribution. The findings show that our Lambda VaR estimations are able to capture the tail risk and react to market fluctuations significantly faster than the VaR and expected shortfall. The backtesting exercise displays a higher level of accuracy for our Lambda VaR estimations