Value at Risk and Credit Risk

In recent years increased volatility in interest rates, exchange rates, and other macroeconomic variables has led us to put greater emphasis on risk management. VAR (Value at Risk) has become a common tool to measure an entity's exposure to market risk. But there are few studies to link VAR with credit risk. This study examines the association between the two with three financial statement-based estimates of VARs. Moreover, we investigate whether the term spread and the default spread affect the VAR metrics. Results indicate that the VAR for speculative grade ratings is significantly higher than t hat for investment grade ratings. After controlling for the 2-score variables, which have been extensively used amongst credit analysts, we provide strong evidence that the VAR metrics are correlated with the credit ratings. Moreover, the findings suggest that the magnitude of the cash statement VAR is positively related to the term spread and the default spread. However, we could not find evidence that the balance sheet VAR and income statement