Backtesting VaR Models: A Τwo-Stage Procedure

Angelidis, Timotheos and Degiannakis, Stavros (2007): Backtesting VaR Models: A Τwo-Stage Procedure. Published in: Journal of Risk Model Validation , Vol. 2, No. 1 (2007): pp. 27-48.

Abstract

Academics and practitioners have extensively studied Value-at-Risk (VaR) to propose a unique risk management technique that generates accurate VaR estimations for long and short trading positions. However, they have not succeeded yet as the developed testing frameworks have not been widely accepted. A two-stage backtesting procedure is proposed in order a model that not only forecasts VaR but also predicts the loss beyond VaR to be selected. Numerous conditional volatility models that capture the main characteristics of asset returns (asymmetric and leptokurtic unconditional distribution of returns, power transformation and fractional integration of the conditional variance) under four distributional assumptions (normal, GED, Student-t, and skewed Student-t) have been estimated to find the best model for three financial markets (US stock, gold and dollar-pound exchange rate markets), long and short trading positions, and two confidence levels. By following this procedure, the risk manager can significantly reduce the number of competing models.

• Item Type: MPRA Paper
• Language: English
• Keywords: Backtesting, Value-at-Risk, Expected Shortfall, Volatility Forecasting, Arch Models
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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