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Forecasting Value-at-Risk and Expected Shortfall in Large Portfolios: a General Dynamic Factor Approach

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  • Marc Hallin
  • Carlos Trucíos

Abstract

Beyond their importance from a regulatory policy point of view, Value-at-Risk (VaR) and Expected Shortfall (ES) play an important role in risk management, portfolio allocation, capital level requirements, trading systems, and hedging strategies. Unfortunately, due to the curse of dimensionality, their accurate estimation in large portfolios is quite a challenge. To tackle this problem, we propose a filtered historical simulation method in which high-dimensional conditional covariance matrices are estimated via a general dynamic factor model with infinite-dimensional factor space and conditionally heteroscedastic factors. The procedure is applied to a panel with concentration ratio close to one. Back-testing and scoring results indicate that both VaR and ES are accurately estimated under our method, which outperforms alternative approaches available in the literature.

Suggested Citation

  • Marc Hallin & Carlos Trucíos, 2020. "Forecasting Value-at-Risk and Expected Shortfall in Large Portfolios: a General Dynamic Factor Approach," Working Papers ECARES 2020-50, ULB -- Universite Libre de Bruxelles.
    • Handle: RePEc:eca:wpaper:2013/315983
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    More about this item

    Keywords

    conditional covariance; high-dimensional time series; large panels; risk measures; volatility;
    All these keywords.

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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