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An Empirical Characteristic Function Approach to VaR under a Mixture of Normal Distribution with Time-Varying Volatility

Dinghai Xu and Tony Wirjanto ()

No 8008, Working Papers from University of Waterloo, Department of Economics

Abstract: This paper considers Value at Risk measures constructed under a discrete mixture of normal distribution on the innovations with time-varying volatility, or MN-GARCH, model. We adopt an approach based on the continuous empirical characteristic function to estimate the param eters of the model using several daily foreign exchange rates' return data. This approach has several advantages as a method for estimating the MN-GARCH model. In particular, under certain weighting measures, a closed form objective distance function for estimation is obtained. This reduces the computational burden considerably. In addition, the characteristic function, unlike its likelihood function counterpart, is always uniformly bounded over parameter space due to the Fourier transformation. To evaluate the VaR estimates obtained from alternative specifications, we construct several measures, such as the number of violations, the average size of violations, the sum square of violations and the expected size of violations. Based on these measures, we find that the VaR measures obtained from the MN-GARCH model outperform those obtained from other competing models.

Keywords: Value at Risk; Mixture of Normals; GARCH; Characteristic Function. (search for similar items in EconPapers)
Date: 2008-12
New Economics Papers: this item is included in nep-ecm and nep-rmg
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