Backtesting and estimation error: value-at-risk overviolation rate

Georges Tsafack () and James Cataldo ()
Additional contact information
Georges Tsafack: University of Rhode Island
James Cataldo: Citizens Financial Group, Model Validation

Empirical Economics, 2021, vol. 61, issue 3, No 8, 1396 pages

Abstract: Abstract Financial institutions and regulators use value-at-risk (VaR) and related measures as a tool for financial risk management. It is therefore critical to appropriately assess the quality of VaR forecasts and reporting. The VaR estimation error creates an additional source of imprecision. We show that even an unbiased estimator of VaR is likely to produce a systematic overviolation. We then propose an adjustment to account for the issue. A Monte Carlo study illustrates the overviolation problem and the effectiveness of the adjustment. An application to Fama–French portfolios returns series highlights the need to further account for tail behavior in the data. Applying the adjustment to the normal distribution performs relatively well for a less prudential level (5% VaR), but is unable to provide enough buffer to overcome the overviolation for more prudential levels (1% or 0.5%VaR). Using the empirical distribution for more prudential levels improves risk forecasts.

Keywords: Risk management; Value-at-risk; Forecasting; Backtesting; Estimation error (search for similar items in EconPapers)
JEL-codes: C1 C52 C53 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://link.springer.com/10.1007/s00181-020-01905-4 Abstract (text/html)
Access to the full text of the articles in this series is restricted.

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:spr:empeco:v:61:y:2021:i:3:d:10.1007_s00181-020-01905-4

Ordering information: This journal article can be ordered from
http://www.springer. ... rics/journal/181/PS2

DOI: 10.1007/s00181-020-01905-4

Access Statistics for this article

Empirical Economics is currently edited by Robert M. Kunst, Arthur H.O. van Soest, Bertrand Candelon, Subal C. Kumbhakar and Joakim Westerlund

More articles in Empirical Economics from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().