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Incorporating the Time-Varying Tail-Fatness into the Historical Simulation Method for Portfolio Value-at-Risk

Author

Listed:
  • Chu-Hsiung Lin

    (Department of Finance, National Kaohsiung First University of Science and Technology, Taiwan, ROC)

  • Chang-Cheng Chang Chien

    (Department of Finance and Banking, Shih Chien University Kaohsiung Campus, National Kaohsiung First University of Science and Technology, Taiwan, ROC)

  • Sunwu Winfred Chen

    (Department of Finance and Banking, Shih Chien University Kaohsiung Campus, National Kaohsiung First University of Science and Technology, Taiwan, ROC)

Abstract

This study extends the method of Guermat and Harris (2002), the Power EWMA (exponentially weighted moving average) method in conjunction with historical simulation to estimating portfolio Value-at-Risk (VaR). Using historical daily return data of three hypothetical portfolios formed by international stock indices, we test the performance of this modified approach to see if it can improve the precise forecasting capability of historical simulation. We explicitly highlight the extended Power EWMA owns privileged flexibilities to capture time-varying tail-fatness and volatilities of financial returns, and therefore may promote the quality of extreme risk management. Our empirical results, derived from the Kupiec (1995) tests and failure ratios, show that our proposed method indeed offers substantial improvements on capturing dynamic returns distributions, and can significantly enhance the estimation accuracy of portfolio VaR.

Suggested Citation

  • Chu-Hsiung Lin & Chang-Cheng Chang Chien & Sunwu Winfred Chen, 2006. "Incorporating the Time-Varying Tail-Fatness into the Historical Simulation Method for Portfolio Value-at-Risk," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 9(02), pages 257-274.
    • Handle: RePEc:wsi:rpbfmp:v:09:y:2006:i:02:n:s0219091506000720
    DOI: 10.1142/S0219091506000720
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    References listed on IDEAS

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    1. WEI, Steven X., 1998. "A censored-GARCH model of asset returns with price limits," LIDAM Discussion Papers CORE 1998015, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
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    More about this item

    Keywords

    Value-at-Risk; historical simulation method; power exponentially weighted moving average;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance

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