Effectiveness of copula-extreme value theory in estimating value-at-risk: empirical evidence from Asian emerging markets

Chun-Pin Hsu (), Chin-Wen Huang () and Wan-Jiun Chiou ()

Review of Quantitative Finance and Accounting, 2012, vol. 39, issue 4, 447-468

Abstract: A traditional Monte Carlo simulation using linear correlations induces estimation bias in measuring portfolio value-at-risk (VaR), due to the well-documented existence of fat-tail, skewness, truncations, and non-linear relations in return distributions. In this paper, we consider the above issues in modeling VaR and evaluate the effectiveness of using copula-extreme-value-based semiparametric approaches. To assess portfolio risk in six Asian markets, we incorporate a combination of extreme value theory (EVT) and various copulas to build joint distributions of returns. A backtesting analysis using a Monte Carlo VaR simulation suggests that the Clayton copula-EVT evinces the best performance regardless of the shapes of the return distributions, and that in general the copulas with the EVT provide better estimations of VaRs than the copulas with conventionally employed empirical distributions. These findings still hold in conditional-coverage-based backtesting. These findings indicate the economic significance of incorporating the down-side shock in risk management. Copyright Springer Science+Business Media, LLC 2012

Keywords: Copulas; Dependence; Emerging markets; EVT; GARCH; Backtesting; G15; F31; C46 (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (7)

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DOI: 10.1007/s11156-011-0261-0

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