An Evaluation Framework for Alternative VAR Models

21 Pages Posted: 31 Jul 2003

See all articles by Christian C. P. Wolff

Christian C. P. Wolff

University of Luxembourg; Centre for Economic Policy Research (CEPR)

Dennis Bams

University of Maastricht - Limburg Institute of Financial Economics (LIFE)

Thorsten Lehnert

University of Luxembourg

Multiple version iconThere are 3 versions of this paper

Date Written: February 2003

Abstract

In this paper we investigate the ability of different models to produce useful VaR-estimates for exchange rate positions. We make a distinction between models that include sophisticated tail properties and models that do not. The former type of models often leads to too extreme VaR-estimates, whereas the latter type underestimates the risk in case of extreme events. Our analysis shows that it is important to take into account parameter uncertainty, since this leads to uncertainty in the reported VaR. We make this uncertainty in the VaR explicit by means of simulation. Our empirical results suggest that more sophisticated tail-modeling approaches come at the cost of more uncertainty about the VaR estimate itself. In the case of the GARCH(1,1)-Student-t model the average VaR may be adjusted for parameter uncertainty to arrive at levels which are adequate according to out-of-sample tests.

Keywords: Value-at-Risk, Financial Time Series, Exchange Rate Positions, GARCH, Estimation Risk, Fat Tail Distributions

Suggested Citation

Wolff, Christian C. P. and Bams, Dennis and Lehnert, Thorsten, An Evaluation Framework for Alternative VAR Models (February 2003). Available at SSRN: https://ssrn.com/abstract=424360 or http://dx.doi.org/10.2139/ssrn.424360

Christian C. P. Wolff (Contact Author)

University of Luxembourg ( email )

6, rue Richard Coudenhove-Kalergi
Kirchberg Campus
Luxembourg, South 1359
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Centre for Economic Policy Research (CEPR)

London
United Kingdom

Dennis Bams

University of Maastricht - Limburg Institute of Financial Economics (LIFE) ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands
+31 43 388 3838 (Phone)
+31 43 325 8530 (Fax)

Thorsten Lehnert

University of Luxembourg ( email )

6, rue Coudenhove-Kalergi
Luxembourg, L-1359
Luxembourg