# Forecasting time-varying value-at-risk

Cecchinato, Nedda
(2010)
*Forecasting time-varying value-at-risk.*
Masters by Research
thesis,
Queensland University of Technology.

## Abstract

In this thesis we are interested in financial risk and the instrument we want to use is Value-at-Risk (VaR). VaR is the maximum loss over a given period of time at a given confidence level. Many definitions of VaR exist and some will be introduced throughout this thesis.

There two main ways to measure risk and VaR: through volatility and through percentiles. Large volatility in financial returns implies greater probability of large losses, but also larger probability of large profits. Percentiles describe tail behaviour. The estimation of VaR is a complex task. It is important to know the main characteristics of financial data to choose the best model. The existing literature is very wide, maybe controversial, but helpful in drawing a picture of the problem. It is commonly recognised that financial data are characterised by heavy tails, time-varying volatility, asymmetric response to bad and good news, and skewness. Ignoring any of these features can lead to underestimating VaR with a possible ultimate consequence being the default of the protagonist (firm, bank or investor).

In recent years, skewness has attracted special attention. An open problem is the detection and modelling of time-varying skewness. Is skewness constant or there is some significant variability which in turn can affect the estimation of VaR?

This thesis aims to answer this question and to open the way to a new approach to model simultaneously time-varying volatility (conditional variance) and skewness. The new tools are modifications of the Generalised Lambda Distributions (GLDs). They are four-parameter distributions, which allow the first four moments to be modelled nearly independently: in particular we are interested in what we will call para-moments, i.e., mean, variance, skewness and kurtosis. The GLDs will be used in two different ways. Firstly, semi-parametrically, we consider a moving window to estimate the parameters and calculate the percentiles of the GLDs. Secondly, parametrically, we attempt to extend the GLDs to include time-varying dependence in the parameters.

We used the local linear regression to estimate semi-parametrically conditional mean and conditional variance. The method is not efficient enough to capture all the dependence structure in the three indices —ASX 200, S&P 500 and FT 30—, however it provides an idea of the DGP underlying the process and helps choosing a good technique to model the data.

We find that GLDs suggest that moments up to the fourth order do not always exist, there existence appears to vary over time. This is a very important finding, considering that past papers (see for example Bali et al., 2008; Hashmi and Tay, 2007; Lanne and Pentti, 2007) modelled time-varying skewness, implicitly assuming the existence of the third moment. However, the GLDs suggest that mean, variance, skewness and in general the conditional distribution vary over time, as already suggested by the existing literature.

The GLDs give good results in estimating VaR on three real indices, ASX 200, S&P 500 and FT 30, with results very similar to the results provided by historical simulation.

Impact and interest:

**Citation counts** are sourced monthly from **Scopus** and **Web of Science®** citation databases.

These databases contain citations from different subsets of available publications and different time periods and thus the citation count from each is usually different. Some works are not in either database and no count is displayed. Scopus includes citations from articles published in 1996 onwards, and Web of Science® generally from 1980 onwards.

Citations counts from the **Google Scholar™** indexing service can be viewed at the linked Google Scholar™ search.

Full-text downloads:

**459**since deposited on 12 May 2010

**51**in the past twelve months

**Full-text downloads** displays the total number of times this work’s files (e.g., a PDF) have been downloaded from QUT ePrints as well as the number of downloads in the previous 365 days. The count includes downloads for all files if a work has more than one.

ID Code: | 32185 |
---|---|

Item Type: | QUT Thesis (Masters by Research) |

Refereed: | No |

Supervisor: | Wolff, Rodney & Anh, Vo |

Keywords: | value-at-risk, generalised lambda distributions, non-parametric volatility estimation, local linear regression |

Divisions: | Past > QUT Faculties & Divisions > Faculty of Science and Technology Past > Schools > Mathematical Sciences |

Institution: | Queensland University of Technology |

Deposited On: | 12 May 2010 04:51 |

Last Modified: | 20 Nov 2012 02:36 |

Export: EndNote | Dublin Core | BibTeX

Repository Staff Only: item control page