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Forecasting multivariate VaR and ES using MC-GARCH-Copula model

Author

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  • Hemant Kumar Badaye
  • Jason Narsoo

Abstract

Purpose - This study aims to use a novel methodology to investigate the performance of several multivariate value at risk (VaR) and expected shortfall (ES) models implemented to assess the risk of an equally weighted portfolio consisting of high-frequency (1-min) observations for five foreign currencies, namely, EUR/USD, GBP/USD, EUR/JPY, USD/JPY and GBP/JPY. Design/methodology/approach - By applying the multiplicative component generalised autoregressive conditional heteroskedasticity (MC-GARCH) model on each return series and by modelling the dependence structure using copulas, the 95 per cent intraday portfolio VaR and ES are forecasted for an out-of-sample set using Monte Carlo simulation. Findings - In terms of VaR forecasting performance, the backtesting results indicated that four out of the five models implemented could not be rejected at 5 per cent level of significance. However, when the models were further evaluated for their ES forecasting power, only the Student’stand Clayton models could not be rejected. The fact that some ES models were rejected at 5 per cent significance level highlights the importance of selecting an appropriate copula model for the dependence structure. Originality/value - To the best of the authors’ knowledge, this is the first study to use the MC-GARCH and copula models to forecast, for the next 1 min, the VaR and ES of an equally weighted portfolio of foreign currencies. It is also the first study to analyse the performance of the MC-GARCH model under seven distributional assumptions for the innovation term.

Suggested Citation

  • Hemant Kumar Badaye & Jason Narsoo, 2020. "Forecasting multivariate VaR and ES using MC-GARCH-Copula model," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 21(5), pages 493-516, January.
  • Handle: RePEc:eme:jrfpps:jrf-06-2019-0114
    DOI: 10.1108/JRF-06-2019-0114
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    Citations

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    Cited by:

    1. Umar, Muhammad & Mirza, Nawazish & Rizvi, Syed Kumail Abbas & Naqvi, Bushra, 2022. "ESG scores and target price accuracy: Evidence from sell-side recommendations in BRICS," International Review of Financial Analysis, Elsevier, vol. 84(C).
    2. Aditya Banerjee & Samit Paul, 2024. "Idiosyncrasies of Intraday Risk in Emerging and Developed Markets: Efficacy of the MCS-GARCH Model and Extreme Value Theory," Global Business Review, International Management Institute, vol. 25(2), pages 468-490, April.

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