Market risk for foreign currency options: Basle's simplified model

We show that capital charges for foreign currency options estimated using a standardized model proposed by the Basle Committee on Banking Supervison a re not consistently related to value at risk (VAR). We propose a simplified incremental model (SIM) and a simplified value at risk (SVAR) model and co mpare them to an internal model based on J.P. Morgan's RiskMetrics(TM). We conclude that it is possible to construct a standardized model that is as e ffective as an internal model, especially for small portfolios. Since inacc urate forecasting under internal models is now subject to penalties, some b anks may prefer standardized models.