Robust Backtesting Tests for Value-at-Risk Models

32 Pages Posted: 24 Nov 2008

See all articles by Juan Carlos Escanciano

Juan Carlos Escanciano

Universidad Carlos III de Madrid

Jose Olmo

Universidad de Zaragoza; University of Southampton

Date Written: November 21, 2008

Abstract

Backtesting methods are statistical tests designed to uncover excessive risk-taking from financial institutions. We show in this paper that these methods are subject to the presence of model risk produced by a wrong specification of the conditional VaR model, and derive its effect on the asymptotic distribution of the relevant out-of-sample tests. We also show that in the absence of estimation risk, the unconditional backtest is affected by model misspecification but the independence test is not. Our solution for the general case consists on proposing robust subsampling techniques to approximate the true sampling distribution of these tests. We carry out a Monte Carlo study to see the importance of these effects in finite samples for location-scale models that are wrongly specified but correct on average. An application to Dow-Jones Index shows the impact of correcting for model risk on backtesting procedures for different dynamic VaR models measuring risk exposure.

Keywords: Backtesting, Basel Accord, Conditional Quantile, Forecast evaluation, Model Risk, Risk management, Value at Risk

JEL Classification: C52, G32

Suggested Citation

Escanciano, Juan Carlos and Olmo, Jose, Robust Backtesting Tests for Value-at-Risk Models (November 21, 2008). Available at SSRN: https://ssrn.com/abstract=1305253 or http://dx.doi.org/10.2139/ssrn.1305253

Juan Carlos Escanciano (Contact Author)

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain
653686785 (Phone)
28907 (Fax)

HOME PAGE: http://https://sites.google.com/view/juancarlosescanciano

Jose Olmo

Universidad de Zaragoza ( email )

Gran Via, 2
50005 Zaragoza, Zaragoza 50005
Spain

University of Southampton ( email )

Southampton
United Kingdom