Back-testing extreme value and Lévy value-at-risk models

Sharif Mozumder, Michael Dempsey and M. Humayun Kabir

Journal of Risk Finance, 2017, vol. 18, issue 1, 88-118

Abstract: Purpose - The purpose of the paper is to back-test value-at-risk (VaR) models for conditional distributions belonging to a Generalized Hyperbolic (GH) family of Lévy processes – Variance Gamma, Normal Inverse Gaussian, Hyperbolic distribution and GH – and compare their risk-management features with a traditional unconditional extreme value (EV) approach using data from future contracts return data of S&P500, FTSE100, DAX, HangSeng and Nikkei 225 indices. Design/methodology/approach - The authors apply tail-based and Lévy-based calibration to estimate the parameters of the models as part of the initial data analysis. While the authors utilize the peaks-over-threshold approach for generalized Pareto distribution, the conditional maximum likelihood method is followed in case of Lévy models. As the Lévy models do not have closed form expressions for VaR, the authors follow a bootstrap method to determine the VaR and the confidence intervals. Finally, for back-testing, they use both static calibration (on the entire data) and dynamic calibration (on a four-year rolling window) to test the unconditional, independence and conditional coverage hypotheses implemented with 95 and 99 per cent VaRs. Findings - Both EV and Lévy models provide the authors with a conservative proportion of violation for VaR forecasts. A model targeting tail or fitting the entire distribution has little effect on either VaR calculation or a VaR model’s back-testing performance. Originality/value - To the best of the authors’ knowledge, this is the first study to explore the back-testing performance of Lévy-based VaR models. The authors conduct various calibration and bootstrap techniques to test the unconditional, independence and conditional coverage hypotheses for the VaRs.

Keywords: Value-at-Risk; Back-testing; Extreme value; Generalized hyperbolic distributions; Lévy–Kintchine formula (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jrfpps:jrf-03-2016-0029

DOI: 10.1108/JRF-03-2016-0029

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