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An Economic Evaluation of the Model Risk for Risk Models

43 Pages Posted: 14 Oct 2011  

Bertrand B. Maillet

EMLyon Business School (Paris Campus)

Christophe Boucher

Université Paris I Panthéon-Sorbonne - CES/CNRS

Patrick Kouontchou

University of Lorraine - CEREFIGE

Date Written: October, 13 2011

Abstract

The recent experience from the global financial crisis has raised serious doubts about the accuracy of standard risk measures as a tool to quantify extreme downward risks. Standard risk measures are subject to a “model risk” due to the specification and estimation uncertainty. We propose a general adjustment of the Value-at-Risk to compute risk measures robust to the model risk. The proposed procedure aims empirically adjusting the imperfect quantile estimate assessing the good quality of VaR models such as frequency exceptions, independence of violations and magnitude of violations. Based on a long sample of U.S. data, we find an inverse U-shape relation between VaR model errors and the horizon: corrections (for model errors) are higher for short-term horizons but are also increasing for long-term horizons. We also provide a fair comparison between the main risk models using the same metric that corresponds to model risk required corrections.

Keywords: Value-at-Risk, Backtesting, Model Risk, Bias Correction

JEL Classification: C50, G11, G32

Suggested Citation

Maillet, Bertrand B. and Boucher, Christophe and Kouontchou, Patrick, An Economic Evaluation of the Model Risk for Risk Models (October, 13 2011). Paris December 2011 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=1943605 or http://dx.doi.org/10.2139/ssrn.1943605

Bertrand B. Maillet (Contact Author)

EMLyon Business School (Paris Campus) ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

Christophe Boucher

Université Paris I Panthéon-Sorbonne - CES/CNRS ( email )

106 bv de l'Hôpital
Paris, 75013
France

Patrick Kouontchou

University of Lorraine - CEREFIGE ( email )

UFR DEA, Ile du Saulcy
Metz, 57045
France
033665778342 (Phone)

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