Assessing the accuracy of exponentially weighted moving average models for Value-at-Risk and Expected Shortfall of crypto portfolios

Carol Alexander and Michael Dakos

Quantitative Finance, 2023, vol. 23, issue 3, 393-427

Abstract: A plethora of academic papers on generalized autoregressive conditional heteroscedasticity (GARCH) models for bitcoin and other cryptocurrencies have been published in academic journals. Yet few, if indeed any, of these are employed by practitioners. Previous academic studies produce results that are fragmented, confusing and conflicting, so there is no commercial incentive to drive an expensive implementation of complex multivariate GARCH models, which anyway would commonly require more data for calibration than are available in the history of most cryptocurrencies, at least at the daily frequency. Consequently, this paper assesses the forecasting accuracy of simple parametric RiskMetrics $ ^{\mbox {\tiny TM}} $ TM type volatility and covariance models, with a focus on ad hoc parameter choice instead of a data-intensive calibration procedure. We provide extensive backtests of hourly and daily Value-at-Risk (VaR) and Expected Shortfall (ES) forecasts that are regarded as best practice in the industry and commonly used for regulatory approval. Our results demonstrate that much simpler models in the exponentially weighted moving average (EWMA) class are just as accurate as GARCH models for VaR and ES forecasting, provided they capture an asymmetric volatility response and a heavy-tailed returns distribution. Moreover, on ranking each model's variance and covariance forecasts using average scores generated from proper univariate and multivariate scoring rules, there is no evidence of superior performance of variance and covariance forecasts generated by GARCH models, using either daily or hourly data.

Date: 2023
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DOI: 10.1080/14697688.2022.2159505

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