Basel IV A gloomy future for Expected Shortfall risk models. Evidence from the Mexican Stock Market

Abstract

To determine the sufficiency of Minimum Capital Requirements (MCR) in Basel IV during financial crises in the Mexican stock market, the paper performs a structural simulation encompassing both the Standardised (SA) and Internal Models Approach (IMA) employing different modelling techniques. The study finds an excessive increase in MCR even in abnormal slumps, furthermore stressing that SA establishes a high floor and only super-leptokurtic models are able to pass its stringent validation standards. Therefore, it is recommended that elements in SA be adaptable to avoid unnecessary capital largeness and the evaluation of the IMA and its interaction with SA revised. Although the outcomes strongly suggest the need to perform adjustments in the regulations, further tests on more markets could help bolster the results, despite the study ranking among the first to assess the adequacy and interplay between Basel IV’s two approaches in Latin American emerging markets. The upshot indicates that Basel IV renders high MCR even for huge falls, placing models at a disadvantage and discouraging its use. The adoption of flexible calibration parameters would align both avenues, facilitating its application.