 Pitfalls in backtesting Historical Simulation VaR modelsJuan Carlos Escanciano and Pei Pei Journal of Banking & Finance, 2012, vol. 36, issue 8, 2233-2244 Abstract: Historical Simulation (HS) and its variant, the Filtered Historical Simulation (FHS), are the most popular Value-at-Risk forecast methods at commercial banks. These forecast methods are traditionally evaluated by means of the unconditional backtest. This paper formally shows that the unconditional backtest is always inconsistent for backtesting HS and FHS models, with a power function that can be even smaller than the nominal level in large samples. Our findings have fundamental implications in the determination of market risk capital requirements, and also explain Monte Carlo and empirical findings in previous studies. We also propose a data-driven weighted backtest with good power properties to evaluate HS and FHS forecasts. A Monte Carlo study and an empirical application with three US stocks confirm our theoretical findings. The empirical application shows that multiplication factors computed under the current regulatory framework are downward biased, as they inherit the inconsistency of the unconditional backtest. Keywords: Backtesting; Basel Accord; Risk management; Value-at-Risk; Conditional quantile; Market risk capital requirements (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:36:y:2012:i:8:p:2233-2244 DOI: 10.1016/j.jbankfin.2012.04.004 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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