Backtesting value-at-risk based on tail losses

Woon K. Wong

Journal of Empirical Finance, 2010, vol. 17, issue 3, 526-538

Abstract: Extreme losses caused by leverage and financial derivatives highlight the need to backtest Value-at-Risk (VaR) based on the sizes of tail losses, because the risk measure currently used disregards losses beyond the VaR boundary. While Basel II backtests VaR by counting the number of exceptions, this paper proposes to use the saddlepoint technique by summing the sizes of tail losses. Monte Carlo simulations show that the technique is extremely accurate and powerful, even for small samples. Empirical applications for the proposed backtest find substantial downside tail risks in S&P 500, and demonstrate that risk models which account for jumps, skewed and fat-tailed distributions failed to capture the tail risk during the 1987 stock market crash. Finally, the saddlepoint technique is used to derive a multiplication factor for any risk capital requirement that is responsive to the sizes of tail losses.

Keywords: Value-at-Risk; Tail; risk; Backtesting; Risk; management; Risk; capital (search for similar items in EconPapers)
Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0927-5398(09)00092-9
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:17:y:2010:i:3:p:526-538

Access Statistics for this article

Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

More articles in Journal of Empirical Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().