ACCURACY VERSUS COMPLEXITY TRADE-OFF IN VaR MODELING: COULD TECHNICAL ANALYSIS BE A SOLUTION?

Evangelos Vasileiou ()
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Evangelos Vasileiou: University of the Aegean, School of Engineering, Department of Financial and Management Engineering, Kountouriotou 41, 82100 Chios, Greece

Journal of Financial Management, Markets and Institutions (JFMMI), 2019, vol. 07, issue 02, 1-22

Abstract: Accurate Value at Risk (VaR) estimations are crucial for the robustness and stability of a financial system. Even though significant advances have been made in the field of risk modeling, many crises have emerged during the same period, and an explanation for this is that the advanced models are not widely applied in the financial industry due to their mathematical complexity. In contrast to the mathematically complex models that torture the data in the output stage, we suggest a new approach that filters the data inputs, based on Technical Analysis (TA) signals. When the trading signals suggest that the conditions are positive (negative) for investments we use data from the previously documented positive (negative) periods in order to calculate the VaR. In this way, we use input data that are more representative of the financial conditions under examination and thus VaR estimations are more accurate and more representative (nonprocyclical) than the conventional models’ estimation that use the last nonfiltered x-day observations. Testing our assumptions in the US stock market for the period 2000–2017, the empirical data confirmed our hypothesis. Moreover, we suggest specific legislative adjustments that contribute to more accurate and representative VaR estimations: (i) an extra backtesting procedure at a lower than the 99% confidence level as a procyclicality test and (ii) to ease the minimum requirement of 250 observations that is currently the input threshold because it leads to less accurate VaR estimations.

Keywords: Value at risk; procyclicality; estimations accuracy; technical analysis; legislative framework (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1142/S2282717X19500038

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