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Using skewed exponential power mixture for VaR and CVaR forecasts to comply with market risk regulation

Author

Listed:
  • Saissi Hassani, Samir

    (HEC Montreal, Canada Research Chair in Risk Management)

  • Dionne, Georges

    (HEC Montreal, Canada Research Chair in Risk Management)

Abstract

We demonstrate how a mixture of two SEP3 densities (skewed exponential power distribution of Fernández et al., 1995) can model the conditional forecasting of VaR and CVaR to efficiently cover market risk at regulatory levels of 1% and 2.5%, as well as at the additional 5% level. Our data consists of a sample of market asset returns, relating to a period of extreme market turmoil, showing typical leptokurtosis and skewness. The SEP3 mixture outcomes are benchmarked using various competing models, including the generalized Pareto distribution. Appropriate scoring functions quickly highlight valuable models, which undergo conventional backtests. As an additional backtest, we argue for and apply the CVaR part of the optimality test of Patton et al. (2019) to assess the conditional adequacy of CVaR. An additional aim of this paper is to present a collaborative framework that relies on both comparative and conventional backtesting tools, all in compliance with the recent Basel regulation for market-risk.

Suggested Citation

  • Saissi Hassani, Samir & Dionne, Georges, 2023. "Using skewed exponential power mixture for VaR and CVaR forecasts to comply with market risk regulation," Working Papers 23-2, HEC Montreal, Canada Research Chair in Risk Management.
    • Handle: RePEc:ris:crcrmw:2023_002
    as

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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Conditional forecasting; VaR; CVaR; backtesting; Basel regulation for market risk; heavy tailed distributions;
    All these keywords.

    JEL classification:

    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • C46 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Specific Distributions
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • 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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