Decomposing and Backtesting a Flexible Specification for CoVaR

44 Pages Posted: 5 Dec 2017

See all articles by Giovanni Bonaccolto

Giovanni Bonaccolto

University "Kore" of Enna

Massimiliano Caporin

University of Padua - Department of Statistical Sciences

Sandra Paterlini

University of Trento - Department of Economics and Management

Date Written: November 26, 2017

Abstract

The Conditional Value-at-Risk (CoVaR) proposed by Adrian and Brunnermeier (2016) - which quantifies the impact of a company in distress on the Value-at-Risk (VaR) of the financial system - has established itself as a reference measure of systemic risk. In this study, we extend the CoVaR along two dimensions, which lead respectively to: i) the Conditional Autoregressive VaR (CoCaViaR), in which we include autoregressive components of conditional quantiles to explicitly capture volatility clustering and heteroskedasticity; ii) the Conditional Quantile Located VaR (QL-CoVaR), which accentuates the degree of distress in the connections between the conditioning companies and the financial system, as the parameters are estimated by directly linking the left tails of their returns' distributions. By combining the two new risk measures, we also build the Conditional Autoregressive Quantile-Located VaR (QL-CoCaViaR) and introduce a new backtesting method. A large empirical analysis highlights the validity of such approaches and critically discuss their pros and cons. In particular, including quantile-located relationships leads to relevant improvements in terms of predictive accuracy during stressed periods and, therefore, provides a valuable tool for regulators to assess systemic events.

Keywords: CoVaR, CaViaR, Systemic Risk, Backtest, Decomposition

Suggested Citation

Bonaccolto, Giovanni and Caporin, Massimiliano and Paterlini, Sandra, Decomposing and Backtesting a Flexible Specification for CoVaR (November 26, 2017). Available at SSRN: https://ssrn.com/abstract=3080427 or http://dx.doi.org/10.2139/ssrn.3080427

Giovanni Bonaccolto (Contact Author)

University "Kore" of Enna ( email )

Viale delle Olimpiadi
Enna, 94100
Italy

Massimiliano Caporin

University of Padua - Department of Statistical Sciences ( email )

Via Battisti, 241
Padova, 35121
Italy

Sandra Paterlini

University of Trento - Department of Economics and Management ( email )

Via Inama 5
Trento, I-38100
Italy

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