Estimating Portfolio Risk for Tail Risk Protection Strategies

Abstract

We forecast portfolio risk for managing dynamic tail risk protection strategies, based on extreme value theory, expectile regression, Copula-GARCH and dynamic GAS models. Utilizing a loss function that overcomes the lack of elicitability for Expected Shortfall, we propose a novel Expected Shortfall (and Value-at-Risk) forecast combination approach, which dominates simple and sophisticated standalone models as well as a simple average combination approach in modelling the tail of the portfolio return distribution. While the associated dynamic risk targeting or portfolio insurance strategies provide effective downside protection, the latter strategies suffer less from inferior risk forecasts given the defensive portfolio insurance mechanics.

Keywords: Tail Risk Protection, CPPI, DPPI, Risk Modelling, Value-at-Risk, Expected Shortfall, Forecast Combination, Return Synchronization

JEL Classification: C13, C14, C22, C53, G11