Value-at-risk in a market subject to regime switching

Ryohei Kawata and Masaaki Kijima

Quantitative Finance, 2007, vol. 7, issue 6, 609-619

Abstract: Many empirical researches report that value-at-risk (VaR) measures understate the actual 1% quantile, while for Inui, K., Kijima, M. and Kitano, A., VaR is subject to a significant positive bias. Stat. Probab. Lett., 2005, 72, 299-311. proved that VaR measures overstate significantly when historical simulation VaR is applied to fat-tail distributions. This paper resolves the puzzle by developing a regime switching model to estimate portfolio VaR. It is shown that our model is able to correct the underestimation problem of risk.

Keywords: VaR; Backtesting; Regime switching; Stochastic volatility; Forecast probability; Smoothed probability; EM algorithm (search for similar items in EconPapers)
Date: 2007
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Citations: View citations in EconPapers (8)

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DOI: 10.1080/14697680601161795

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