A theoretical framework incorporating the basic convergence effect in the value-at-risk model

An early VaR technique, Delta Valuation (Jorion (2000)), which considers the first partial derivatives, is generally adopted in evaluating the risk exposures of futures. However, we believe that if the poor assumption where the basic convergence effect of the relationship between futures prices and spot prices presumed in Delta Valuation is ignored, it will lead to the predicted VaR of futures being consistently underestimated. Hence, an adjusted model that incorporates the basic convergence effect into the risk valuation process is highly encouraged in this article as a replacement for the traditional model. Our empirical results indicate that there is a significant improvement in the accuracy of the predicted estimates using the adjusted model as compared with the traditional model. The evidence supports the adoption of an approach that uses the adjusted model proposed in this paper to estimate the VaR for futures data.