Filtered Extreme Value Theory for Value-At-Risk Estimation

Ozun, Alper and Cifter, Atilla and Yilmazer, Sait (2007): Filtered Extreme Value Theory for Value-At-Risk Estimation.

Abstract

Extreme returns in stock returns need to be captured for a successful risk management function to estimate unexpected loss in portfolio. Traditional value-at-risk models based on parametric models are not able to capture the extremes in emerging markets where high volatility and nonlinear behaviors in returns are observed. The Extreme Value Theory (EVT) with conditional quantile proposed by McNeil and Frey (2000) is based on the central limit theorem applied to the extremes rater than mean of the return distribution. It limits the distribution of extreme returns always has the same form without relying on the distribution of the parent variable. This paper uses 8 filtered EVT models created with conditional quantile to estimate value-at-risk for the Istanbul Stock Exchange (ISE). The performances of the filtered expected shortfall models are compared to those of GARCH, GARCH with student-t distribution, GARCH with skewed student-t distribution and FIGARCH by using alternative back-testing algorithms, namely, Kupiec test (1995), Christoffersen test (1998), Lopez test (1999), RMSE (70 days) h-step ahead forecasting RMSE (70 days), number of exception and h-step ahead number of exception. The test results show that the filtered expected shortfall has better performance on capturing fat-tails in the stock returns than parametric value-at-risk models do. Besides increase in conditional quantile decreases h-step ahead number of exceptions and this shows that filtered expected shortfall with higher conditional quantile such as 40 days should be used for forward looking forecasting.

• Item Type: MPRA Paper
• Institution: Marmara University
• Language: English
• Keywords: Value at-Risk; Filtered Expected shortfall; Extreme value theory; emerging markets
• Subjects: 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; G - Financial Economics > G0 - General; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C52 - Model Evaluation, Validation, and Selection

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