The Performance of Value at Risk Models During the Crisis
Journal of Risk Model Validation, Vol. 4(1), (2010)
Posted: 28 Mar 2013 Last revised: 11 Apr 2013
Date Written: March 25, 2010
Using stock data that covers the period from 6th April 2001 to 17th June 2009, including data for the recent crisis period, we perform Value at Risk risk model validation by backtesting the performance of VaR models in predicting future losses of a portfolio of stocks, futures and options. The stock returns are modeled using univariate GARCH models for the stock returns with different assumptions on the distribution of the univariate model residuals such as normal distribution, t-distribution, empirical distribution with t-distributed tails. To capture co-dependence between financial return series we model dependence using the normal copula, the t-copula and the discrete normal mixture copula. Backtesting evaluations of different models indicate that inclusion of GARCH models for estimating and forecasting volatility make a significant contribution to the accuracy of VaR models. The contribution is both in terms of making VaR models match the expected number of VaR exceedances of losses and the VaR model exceedances having expected durations between them. However, while stochastic volatility is an important component of VaR model specifications it is not the only component. In particular, the choice of univariate model for the GARCH residuals and the choice of copula also affects the VaR model performance. Standard practice models used in Value at Risk estimation such as the deltanormal model, the covariance simulation model, with or without Risk Metrics covariance matrix, and the historical simulation model are shown to underestimate risk quite severely while models such as the discrete normal variance mixture copula with univariate GARCH performs well.
Keywords: VaR model performance, back testing, VaR models during crisis
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