Backtesting value-at-risk a duration-based approach pdf download

Backtesting value at risk forecasts is an important issue. Table 1 gives the results, based on 10,000 simulations. We could also use the gamma distribution under the alternative hypothesis. Financial risk model evaluation or backtesting is a key part of the. Methods suggested in berkowitz 2001 fare better, but rely.

C22, c52, g28 1 the authors thank enrique sentana for comments on the paper as well as the participants of the methods in international finance network 2008. Backtesting tests of 5% var forecasts for nasdaq index var forecasting methods. Financial risk model evaluation or backtesting is a key part of the internal models approach to market risk management as laid out by the basle. The first had limited circulation, being distributed at the firms 1994 annual research conference, which was in budapest.

This code computes the gmm durationbased var backtesting test proposed by candelon et al. However, existing backtesting methods have relatively low power in realistic small sample settings. Jp morgans riskmetrics technical document was released in four editions between 1994 and 1996. Here and elsewhere, we do not include results for additional tests for unconditional and conditional coverage, as we think it would be unfair to check these outside their home territory, so to speak. A durationbased approach financial risk model evaluation or backtesting is a key part of the internal models approach to market risk management as laid. Value at risk var is a widely used measure of downside investment risk for a single investment or a portfolio of investments. Backtesting is way of testing if a models predictions are in line with realised data. Using simple jstatistic based on the moments defined by the orthonormal polynomials associated with the geometric. This paper proposes a new durationbased backtesting procedure for var forecasts. Their method is very appealing because it allows one to test for both correct conditional and unconditional coverage against quite general alternatives, thus generalizing earlier approaches. Authored by enterprise risk management initiative staff.

Our contribution is the exploration of new tools for backtesting based on the duration of days between the violations of the value at risk. We calculate the n j and and find their sample correlation to be 0. In order to evaluate the quality of the var estimates, the models should always be backtested with appropriate methods. Our contribution is the exploration of new tools for backtesting based on the. Lr iid mar is the likelihood ratio test for independence proposed by christoffersen 1998 against a firstorder markov alternative. In the case of the weibull distribution, the pdf takes the form.

Using simple jstatistic based on the moments defined by the orthonormal. Under the null of cc, the durations have an exponential distribution with a rate parameter equal. Besides, we study the consequences of the estimation risk on the durationbased backtesting tests and propose a subsampling approach for robust inference derived from escanciano and olmo 2009. Peter christoffersen authors registered in the repec author service. Value at risk has become one of the most popular risk measurement techniques in finance. Evaluation of volatility models for forecasting valueat. However, existing backtesting methods such as those developed in christoffersen 1998, have relatively small power in realistic small sample settings. Denis pelletier journal of financial econometrics, 2004, vol. Backtesting is the process of testing a trading strategy on relevant historical data to ensure its viability before the trader risks any actual capital. However, existing backtesting methods such as those developed in christoffersen 1998, have relatively. Dynamic development in the area of value at risk var estimation and growing implementation of based risk valuation models in investment companies var. Financial risk model evaluation or backtesting is a key part of the internal models approach to market risk management as laid out by the basle committee on banking supervision. However, existing backtesting methods such as those developed in christoffersen 1998, have relatively small power in realistic. If actual losses are consistently higher, the model is underestimating risk.

Backtesting a risk model, for instance, is typically done by checking if actual historical losses on a portfolio are very different from the losses predicted by the model. See also christoffersen and pelletier 2004, haas 2005, and berkowitz et al. Here we shall address issues and present practical advice on how to proceed. This code computes two lr duration based test statistics derived from christoffersen and pelletier 2004.

Value at risk, backtesting, gmm, duration based test. Backtesting is a process of assessing the usefulness of a value at risk measures predictions when applied to a particular portfolio over time. Financial risk model evaluation or backtesting is a key part of the internal models approach to market risk management as laid out by the basle commitee on. Backtesting var is used to compare the forecastpredicted losses from the. Third, montecarlo simulations show that for realistic sample sizes, our gmm test outperforms traditional duration based test. Denition we dene a super exception using a var with a much smaller coverage probability. A durationbased approach peter christoffersen mcgill university, cirano, and cireq denis pelletier north carolina state university abstract financial risk model evaluation or backtesting is a key part of the internal models approach to market risk management as laid out by the basle committee on banking supervision. For some notable backtesting methodologies not discussed in this chapter, see haas 2001, engle and manganelli 2004, and ziggel et al. This paper proposes a new durationbased backtesting procedure for value at risk var forecasts. Backtesting is a technique for simulating a model or strategy on past data to gauge its accuracy and effectiveness. In particular, it is among the rst to take into account problems induced by the estimation risk in durationbased backtesting tests and to o. The gmm test framework proposed by bontemps 2006 to test for the distributional assumption i. However, existing backtesting methods such as those developed in.

Citeseerx document details isaac councill, lee giles, pradeep teregowda. If they are lower, the model is overestimating risk. This paper 1 proposes a new durationbased backtesting procedure for var forecasts. A simple and focused backtest of value at risk sciencedirect. These backtesting tests are based on the durations observed between two consecutive hits var violations. However, existing backtesting methods such as those developed in christoffersen 1998 have relatively small power in realistic small sample settings. A durationbased approach has recently been proposed by christoffersen and pelletier 2004. Financial risk model evaluation or backtesting is a key part of the internal models approach to market risk management as laid out by the basle committee on banking supervision 1996. Download acrobat pdf file 295kb supplementary data s1. Using simple jstatistic based on the moments defined by the orthonormal polynomials associated with the. However, var models are useful only if they predict future risks accurately.