Approximation methods for multiple period Value at Risk and Expected Shortfall prediction

Carl Lönnbark

Quantitative Finance, 2016, vol. 16, issue 6, 947-968

Abstract: In this paper, we are interested in predicting multiple period Value at Risk and Expected Shortfall based on the so-called iterating approach. In general, the properties of the conditional distribution of multiple period returns do not follow easily from the one-period data generating process, rendering this a non-trivial task. We outline a framework that forms the basis for setting approximations and study four different approaches. Their performance is evaluated by means of extensive Monte Carlo simulations based on an asymmetric GARCH model, implying conditional skewness and excess kurtosis in the multiple period returns. This simulation-based approach was the best one, closely followed by that of assuming a skewed t -distribution for the multiple period returns. The approach based on a Gram--Charlier expansion was not able to cope with the implied non-normality, while the so-called Root- k approach performed poorly. In addition, we outline how the delta-method may be used to quantify the estimation error in the predictors and in the Monte Carlo study we found that it performed well. In an empirical illustration, we computed 10-day Value at Risk’s and Expected Shortfall for Brent Crude Oil, the EUR/USD exchange rate and the S&P 500 index. The Root- k approach clearly performed the worst and the other approaches performed quite similarly, with the simulation based approach and the one based on the skewed t -distribution somewhat better than the one based on the Gram--Charlier expansion.

Date: 2016
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DOI: 10.1080/14697688.2015.1117647

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