Model Averaging in Risk Management with an Application to Futures Markets

52 Pages Posted: 26 Feb 2008

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

University of Southern California - Department of Economics

Christoph Schleicher

Bank of England

Paolo Zaffaroni

Imperial College Business School

Date Written: February 2008

Abstract

This paper considers the problem of model uncertainty in the case of multi-asset volatility models and discusses the use of model averaging techniques as a way of dealing with the risk of inadvertently using false models in portfolio management. Evaluation of volatility models is then considered and a simple Value-at-Risk (VaR) diagnostic test is proposed for individual as well as 'average' models. The asymptotic as well as the exact finite-sample distribution of the test statistic, dealing with the possibility of parameter uncertainty, are established. The model averaging idea and the VaR diagnostic tests are illustrated by an application to portfolios of daily returns on six currencies, four equity indices, four ten year government bonds and four commodities over the period 1991-2007. The empirical evidence supports the use of 'thick' model averaging strategies over single models or Bayesian type model averaging procedures.

Keywords: model averaging, Value-at-Risk, decision based evaluations

JEL Classification: C32, C52, C53, G11

Suggested Citation

Pesaran, M. Hashem and Schleicher, Christoph and Zaffaroni, Paolo, Model Averaging in Risk Management with an Application to Futures Markets (February 2008). CESifo Working Paper Series No. 2231, IEPR Working Paper No. 08.3, Available at SSRN: https://ssrn.com/abstract=1097516

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

Christoph Schleicher

Bank of England ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom
+44 0207 601 4115 (Phone)
+44 0207 601 5953 (Fax)

Paolo Zaffaroni

Imperial College Business School ( email )

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
246
Abstract Views
1,268
rank
155,144
PlumX Metrics