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Old-fashioned parametric models are still the best: a comparison of value-at-risk approaches in several volatility states

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  • Mateusz BuczyÅ„ski
  • Marcin Chlebus

Abstract

Numerous advances in the modeling techniques of value-at-risk (VaR) have;provided financial institutions with a wide range of market risk approaches. However, which model to use depends on the state of volatility. We present backtesting results for 1% and 2.5% VaR of six indexes from emerging and developed countries using several of the best-known VaR models, including generalized autoregressive conditional heteroscedasticity (GARCH), extreme value theory (EVT), conditional autoregressive VaR (CAViaR) and filtered historical simulation (FHS) with multiple sets of parameters. The backtesting procedure is based on the excess ratio, Kupiec and Christoffersen tests for multiple thresholds and cost functions. The main contribution of this paper is that we compared the models in four different scenarios, with different states of volatility in the training and testing samples. The results indicate that the best of the models, ie, the least affected by changes in the volatility, is GARCH(1,1) with a standardized Student t distribution. Nonparametric techniques (eg, CAViaR with GARCH setup or FHS with a skewed normal distribution) have very prominent results in testing periods with low volatility, but they are worse in turbulent periods. We also discuss an automatic method to set an extreme distribution threshold for EVT models as well as several ensembling methods for VaR, of which the minimum VaR estimate from the best models – in particular, a minimum of GARCH(1,1) with a standardized Student t distribution and either the EVT or the CAViaR model – has been proven to give very good results.

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  • Mateusz BuczyÅ„ski & Marcin Chlebus, . "Old-fashioned parametric models are still the best: a comparison of value-at-risk approaches in several volatility states," Journal of Risk Model Validation, Journal of Risk Model Validation.
    • Handle: RePEc:rsk:journ5:7553981
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    Cited by:

    1. Szymon Lis & Marcin Chlebus, 2021. "Comparison of the accuracy in VaR forecasting for commodities using different methods of combining forecasts," Working Papers 2021-11, Faculty of Economic Sciences, University of Warsaw.
    2. Aleksander Schiffers & Marcin Chlebus, 2021. "The effectiveness of Value-at-Risk models in various volatility regimes," Working Papers 2021-28, Faculty of Economic Sciences, University of Warsaw.
    3. Murphy, David & Vause, Nicholas, 2021. "A CBA of APC: analysing approaches to procyclicality reduction in CCP initial margin models," Bank of England working papers 950, Bank of England.

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    More about this item

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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