EWS-GARCH: New Regime Switching Approach to Forecast Value-at-Risk

Marcin Chlebus ()

No 2016-06, Working Papers from Faculty of Economic Sciences, University of Warsaw

Abstract: In the study a proposal of two-step EWS-GARCH models to forecast Value-at-Risk is presented. The EWS-GARCH allows different distributions of returns to be used in Value-at-Risk forecasting depending on a forecasted state of the financial time series. In the study EWS-GARCH with GARCH(1,1) and GARCH(1,1) with the amendment to the empirical distribution of returns as a Value-at-Risk model in a state of tranquillity and empirical tail, exponential or Pareto distributions used to forecast Value-at-Risk in a state of turbulence were considered. The evaluation of the quality of the Value-at-Risk forecasts was based on the Value-at-Risk forecasts adequacy (the excess ratio, the Kupiec test, the Christoffersen test, the asymptotic test of unconditional coverage and the back-testing criteria defined by the Basel committee) and the analysis of loss functions (the Lopez quadratic loss function, the Abad & Benito absolute loss function, the 3rd version of Caporin loss function and proposed in the study the function of excessive costs). Obtained results indicate that the EWS-GARCH models may improve the quality of the Value-at-Risk forecasts generated using benchmark models. However, the choice of best assumptions for an EWS-GARCH model should depend on the goals of the Value-at-Risk forecasting model. The final selection may depend on an expected level of adequacy, conservatism and costs of a model.

Keywords: Value-at-Risk; GARCH; forecasting; state of turbulence; regime switching; risk management; risk measure; market risk. (search for similar items in EconPapers)
JEL-codes: C51 C52 C53 G17 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2016
New Economics Papers: this item is included in nep-ets, nep-for and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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http://www.wne.uw.edu.pl/index.php/download_file/2440/ First version, 2016 (application/pdf)

Related works:
Journal Article: EWS-GARCH: New Regime Switching Approach to Forecast Value-at-Risk (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:war:wpaper:2016-06

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