Optimality of the Riskmetrics Model

Posted: 23 Nov 2011 Last revised: 24 Nov 2011

See all articles by Gloria González-Rivera

Gloria González-Rivera

University of California, Riverside (UCR) - Department of Economics

Tae-Hwy Lee

University of California, Riverside (UCR) - Department of Economics

Emre Yoldas

Board of Governors of the Federal Reserve System

Date Written: April 15, 2007

Abstract

Using different loss functions in estimation and forecast evaluation of econometric models can cause suboptimal parameter estimates and inaccurate assessment of predictive ability. Though there are not general guidelines on how to choose the loss function, the modeling of Value-at-Risk is a rare instance is which the loss function for forecasting evaluation is well defined. Within the context of the RiskMetrics methodology, which is the most popular to calculate Value-at-Risk, we investigate the implications of considering different loss functions in estimation and forecasting evaluation. Based on U.S. equity, exchange rates, and bond market data we find that there can be substantial differences on the estimates under alternative loss functions. On calculating the 99% VaR for a 10-day horizon, the RiskMetrics model for equity markets overestimates substantially the decay factor. However, the out-of-sample performance is not systematically superior by using the estimates under the correct loss function.

Keywords: Estimation, Forecasting, Loss functions, Optimality, VaR

JEL Classification: C22, C52, C53, G0

Suggested Citation

González-Rivera, Gloria and Lee, Tae-Hwy and Yoldas, Emre, Optimality of the Riskmetrics Model (April 15, 2007). Finance Research Letters, Vol. 4, No. 3, 2007, Available at SSRN: https://ssrn.com/abstract=1963219

Gloria González-Rivera

University of California, Riverside (UCR) - Department of Economics ( email )

900 University Avenue
4136 Sproul Hall
Riverside, CA 92521
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Tae-Hwy Lee

University of California, Riverside (UCR) - Department of Economics ( email )

900 University Avenue
4136 Sproul Hall
Riverside, CA 92521
United States

Emre Yoldas (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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