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CAViaR :Conditional Value at Risk By Regression Quantiles
Robert Engle and Simone Manganelli
U.C.S.D.July 1999
2
Value at Risk is a single measure of market risk of a firm, portfolio, trading desk, or other economic entity.
It is defined by a significance level and a horizon. For convenience consider 5% and 1 day.
Any loss tomorrow will be less than the Value at Risk with 95% certainty
3
HISTOGRAM OF TOMORROW’S VALUE - BASED ON PAST RETURNS
0 . 0
0 . 2
0 . 4
0 . 6
0 . 8
- 2 0 - 1 5 - 1 0 - 5 0 5
S & P 5 0 0 % R E T U R N S
K e r n e l D e n s i t y ( N o r m a l , h = 0 . 1 1 4 5 )
4
CUMULATIVE DISTRIBUTION
0.0
0.2
0.4
0.6
0.8
1.0
-20 -10 0 10
Empirical CDF of S&P500 RETURNS
5
Weakness of this measure
• The amount we exceed VaR is important
• There is no utility function associated with this measure
• The measure assumes assets can be sold at their market price - no consideration for liquidity
• But it is simple to understand and very widely used.
6
THE PROBLEM
• FORECAST QUANTILE OF FUTURE RETURNS
• MUST ACCOMMODATE TIME VARYING DISTRIBUTIONS
• MUST HAVE METHOD FOR EVALUATION
• MUST HAVE METHOD FOR PICKING UNKNOWN PARAMETERS
7
TWO GENERAL APPROACHES• FACTOR MODELS--- AS IN
RISKMETRICS
• PORTFOLIO MODELS--- AS IN ROLLING HISTORICAL QUANTILES
8
FACTOR MODELS
– Volatilities and correlations between factors are estimated
– These volatilities and correlations are updated daily
– Portfolio standard deviations are calculated from portfolio weights and covariance matrix
– Value at Risk computed assuming normality
9
PORTFOLIO MODELS
• Historical performance of fixed weight portfolio is calculated from data bank
• Model for quantile is estimated
• VaR is forecast
10
COMPLICATIONS
• Some assets didn’t trade in the past- approximate by deltas or betas
• Some assets were traded at different times of the day - asynchronous prices-synchronize these
• Derivatives may require special assumptions - volatility models and greeks.
11
PORTFOLIO MODELS - EXAMPLES• Rolling Historical : e.g. find the 5%
point of the last 250 days• GARCH : e.g. build a GARCH model to
forecast volatility and use standardized residuals to find 5% point
• Hybrid model: use rolling historical but weight most recent data more heavily with exponentially declining weights.
12
THE CAViaR STRATEGY
• Define a quantile model with some unknown parameters
• Construct the quantile criterion function• Optimize this criterion over the
historical period• Formulate diagnostic checks for model
adequacy• Try it out!
13
Mathematical Formulation
Find VaR satisfying
where y are returns and is probability
Must be able to calculate VaR one day in advance and to estimate unknown parameters.
)(
1ttVaRyP
14
SPECIFICATIONS FOR VaR
• VaR is a function of observables in t-1
• VaR=f(VaR(t-1), y(t-1), parameters)
• For example - the Adaptive Model
)(
)(11
ttt
ttt
VaRyIhit
hitVaRVaR
15
How to compute VaR
If beta is known, then VaR can be calculated for the adaptive model from a starting value.
.....)3(
hit no if (-.05)*
1in hit if .95*VaR(1)VaR(2)
1.65VaR(1)Let
VaR
16
CAViaR News Impact Curve
17
More Specifications
• Proportional Symmetric Adaptive
• Symmetric Absolute Value:
• Asymmetric Absolute Value:
)VaRy()VaRy(VaRVaR 1t1t21t1t11tt
1t21t101t yVaRVaR
31t21t101t yVaRVaR
18
• Asymmetric Slope
• Indirect GARCH
1t31t21t10t yyVaRVaR
2/12
1t2
21t
10t yk
VaRkVaR
19
20
Koenker and Bassett(1978) maximize
Where f is the quantile which depends on past information and parameters beta
The criterion minimizes absolute errors where positive and negative errors are weighted differently
)()(
210)()(
ttt
ttt
fyhit
fyIfyQ
21
Quantile Objective Function
22
Even though the quantile function is non-differentiable at some points, the first order conditions must be satisfied with probability one.
Hits should be unpredictable and are uncorrelated with regressors at an optimum
0'
/)(
0/)ˆ(
Xhit
fX
fhit
tt
tt
23
Adaptive Criterion
-0.118
-0.116
-0.114
-0.112
-0.110
-0.108
500 1000 1500 2000 2500 3000
Quantile Criterion - Adaptive
24
Asymmetric Criterion
-0.17
-0.16
-0.15
-0.14
-0.13
-0.12
500 1000 1500 2000 2500 3000
Likelihood from CAViaR1
25
Optimization by Genetic Algorithm• DIFFERENTIAL EVOLUTIONARY GENETIC
ALGORITHM - Price and Storn(1997)
• Start with initial population of trial values
• Reproduction based on fitness
• Crossover to find next generation
• Mutation - random new elements
• Stopping Criterion
26
Testing the Model
• Should have the right proportion of hits
• Should have no autocorrelation
• Probability of exceeding VaR should be independent of VaR (no measurement error)
• Should be testable both in-sample and out-of-sample
27
28
Tests
• Cowles and Jones (1937)
• Runs - Mood (1940)
• Ljung Box on hits (1979)
• Dynamic Quantile Test
29
Dynamic Quantile Test
To test that hits have the same distribution regardless of past observables
Regress hit on– constant– lagged hits– Value at Risk– lagged returns– other variables such as year dummies
30
Distribution Theory
• If out of sample test , or
• If all parameters are known
• Then TR02 will be asymptotically
Chi Squared and F version is also available
• But the distribution is slightly different otherwise
31
Mathematical Statistics References• Koenker and Bassett(1978) no
dynamics
• Weiss(1991) least absolute deviation
• Newey and McFadden(1994)
32
Mathematical Statistics
)(maxarg
)(maxargˆ
0)r( to
Q
nQ
fyfyIn
Q
subject
tttt
hitXDRRADRDRXDhitn
ADDNn
Then
LM
d
''''
)1(,0ˆ
111111
110
33
Mathematical Assumptions
0n1/ and ,
2/Q )8(
matrixsingular -non a ,/' )7(
),0()(n )6(
ofdensity theish where,'n
1 )5(
of odneighborho ain singular non , )4(
oney probabilit with ),()(1
Q )3(
)( )2(
at maximizeduniquely is ,)( )1(
0
0000
0
0
02
00
p
p
d
ptt
tt
p
remainderremainder
DQQ
AnXX
ANQ
(y-f)DXXh
DQE
Xhitn
Rr
QQE
34
Estimating Standard Errors
ofdensity lconditiona theis where
,'n1
0
-fy h
DXXh
ttt
pttt
• To calculate standard errors-must estimate D• D weights X by the height of the conditional
density of returns at the estimated quantile• Should estimate this without making assumptions
on the shape of the density
35
A Picture Gives Intuition
0.0
0.2
0.4
0.6
0.8
1.0
200 400 600 800 1000
Y1 Y2
STANDARD DEVIATION OF Y1 IS TWICE Y2BOTH ARE GAUSSIAN
36
0.0
0.2
0.4
0.6
0.8
1.0
200 400 600 800 1000
Y1Y2
Q1_1/10Q2_1/10
1% QUANTILE POINTS
37
0.00
0.05
0.10
0.15
0.20
0.25
220 240 260 280 300 320 340 360 380 400
Y1Y2
Q1_1/10Q2_1/10
1% QUANTILE POINTS
38
0.0
0.1
0.2
0.3
0.4
0.5
300 320 340 360 380 400 420 440
Y1Y2
Q1_5/5Q2_5/5
5% QUANTILE
39
0.0
0.1
0.2
0.3
0.4
0.5
200 400 600 800 1000
Y1Y2/2
Q1_5/10Q2_5/10
Density of Y2 divided by its standard deviation
40
Assumption
• Define
• Therefore• And• NOW ASSUME:
tt
ttt g
f
fy~
ttt fhg
ttt fgh /)0()0(
.f hborhood ofor a Neigfor all t ugugt 0)()(
41
Estimate g Non-parametrically:
• where k is a uniform kernel accepting points between -1 and 1
• and for 2900 observations empirically we chose cn=.05
tt fgh ˆ/)0(ˆ)0(ˆ
ntn ckncg /0ˆ 1
42
43
A little Monte Carlo
• 100 samples of 2000 observations of GARCH(1,1) with parameters (.3, .05, .90)
• Estimate with Indirect GARCH CAViaR model
• Mean parameters are (.42, .05, .88)
• Some are far off showing no persistence
• Trimming 10 extremes, means become (.31,.05,.90 )
44
Table 1 - Summary statistics of the Monte Carlo experiment
0.1% GAMMA1 GAMMA2 GAMMA3
True mean 4.15 0.90 0.69
Mean 7.16 0.80 0.67
t-statistic 8.54 -13.60 -0.95
Median 2.90 0.89 0.53
125.16 -2.45 2.60
Var-Cov matrix -2.45 0.05 -0.07
2.60 -0.07 0.32
1% GAMMA1 GAMMA2 GAMMA3
True mean 1.62 0.90 0.27
Mean 2.28 0.87 0.30
t-statistic 7.59 -7.91 6.01
Median 1.57 0.90 0.27
7.79 -0.28 0.19
Var-Cov matrix -0.28 0.01 -0.01
0.19 -0.01 0.02
45
5% GAMMA1 GAMMA2 GAMMA3True mean 0.81 0.90 0.135
Trimmed Mean 0.99 0.89 0.14Trimmed Median 0.81 0.90 0.14
0.49 -0.04 0.02Trimmed Var-Cov matrix -0.04 0.00 0.00
0.02 0.00 0.00
25% GAMMA1 GAMMA2 GAMMA3True mean 0.13 0.90 0.027
Trimmed Mean 0.18 0.88 0.03Trimmed Median 0.13 0.90 0.02
0.03 -0.01 0.00Trimmed Var-Cov matrix -0.01 0.01 0.00
0.00 0.00 0.00
46
Table 2 - Monte Carlo summary statistics after trimming the samples with GAMMA2<0.5
0.1% GAMMA1 GAMMA2 GAMMA3True mean 4.15 0.90 0.69
Trimmed Mean 4.04 0.87 0.60Trimmed Median 2.49 0.90 0.50
18.36 -0.40 0.81Trimmed Var-Cov matrix -0.40 0.01 -0.03
0.81 -0.03 0.23
1% GAMMA1 GAMMA2 GAMMA3True mean 1.62 0.90 0.27
Trimmed Mean 2.02 0.88 0.29Trimmed Median 1.55 0.90 0.27
2.72 -0.11 0.12Trimmed Var-Cov matrix -0.11 0.00 -0.01
0.12 -0.01 0.02
47
Applications
• Daily data from April 7, 1986 to April 7, 1999 - 3392 observations
• Save the last 500 for out- of- sample tests
• GM, IBM, S&P500
• Fit all 6 models for 5% ,1% , .1% and 25% VaR.
48
-30
-20
-10
0
10
20
500 1000 1500 2000 2500 3000
GM
-30
-20
-10
0
10
20
500 1000 1500 2000 2500 3000
IBM
-30
-20
-10
0
10
500 1000 1500 2000 2500 3000
S&P500
49
News Impact Curve - 1% SP
2
4
6
8
10
12
200 400 600 800 1000
VAR_ADAPTIVEVAR_ASY_ABSVAR_ASY_SLOP
VAR_IND_GARCHVAR_PRO_SYM_ADAVAR_SYM_ABS
50
Caviar News Impact Curves SP500 at 5%
0
1
2
3
4
5
50 100 150 200 250 300 350 400
A
0
1
2
3
4
5
50 100 150 200 250 300 350 400
PSA
0
1
2
3
4
5
50 100 150 200 250 300 350 400
SAV
0
1
2
3
4
5
50 100 150 200 250 300 350 400
AAV
0
1
2
3
4
5
50 100 150 200 250 300 350 400
AS
0
1
2
3
4
5
50 100 150 200 250 300 350 400
G
51
1% and 5% News Impact Curves
1
2
3
4
5
200 400 600 800 1000
VAR_AS_5 VAR_ASY_SLOP
52
Table 3 - Parameter estimates -Statistics for the Adaptive model
ADAPTIVE *** 5% GM IBM S&P 500 ADAPTIVE *** 25% GM IBM S&P 500Gamma 1 0.22 0.44 0.23 Gamma 1 0.021 0.012 0.017Standard Errors 0.03 0.05 0.02 Standard Errors 0.004 0.003 0.003P-values 0.00 0.00 0.00 P-values 0.000 0.000 0.000RQ in sample 553.26 527.45 312.65 RQ in sample 1507 1368 752RQ out of sample 100.84 120.20 72.41 RQ out of sample 291.62 312.44 184Hits in sample (%) 4.91 5.01 5.08 Hits in sample (%) 24.86 25.31 25.07Hits out of sample (%) 6.40 5.20 5.00 Hits out of sample (%) 27.00 24.80 27.40DQ in sample (p-values) DQ in sample (p-values)1) [c, hit(-1 to -5)] 0.31 0.47 0.46 1) [c, hit(-1 to -5)] 0.94 0.25 0.592) [VaR] 0.52 0.34 0.48 2) [VaR] 0.73 0.80 0.683) [c, hit(-1), VaR] 0.12 0.01 0.10 3) [c, hit(-1), VaR] 0.58 0.64 0.304) [c, hit(-1 to -5), VaR] 0.06 0.01 0.07 4) [c, hit(-1 to -5), VaR] 0.81 0.23 0.32DQ out of sample (p-values) DQ out of sample (p-values)1) [c, hit(-1 to -5)] 0.40 0.98 0.01 1) [c, hit(-1 to -5)] 0.57 0.67 0.452) [VaR] 0.26 0.90 0.80 2) [VaR] 0.43 0.97 0.293) [c, hit(-1), VaR] 0.40 0.21 0.55 3) [c, hit(-1), VaR] 0.23 0.28 0.394) [c, hit(-1 to -5), VaR] 0.45 0.56 0.01 4) [c, hit(-1 to -5), VaR] 0.64 0.30 0.41
53
ASYM SLOPE *** 0.1% GM IBM S&P 500 ASYM SLOPE *** 1% GM IBM S&P 500Gamma 1 2.7753 1.0863 0.4325 Gamma 1 0.3928 0.0572 0.1473Standard Errors - - - Standard Errors 0.2216 0.0580 0.0833P-values - - - P-values 0.0381 0.1623 0.0385
Gamma 2 0.4342 0.6587 0.6871 Gamma 2 0.7983 0.9427 0.8699Standard Errors - - - Standard Errors 0.0676 0.0227 0.0484P-values - - - P-values 0.0000 0.0000 0.0000
Gamma 3 0.6130 1.1402 1.8655 Gamma 3 0.2725 0.0512 0.0001Standard Errors - - - Standard Errors 0.1148 0.0616 0.1168P-values - - - P-values 0.0088 0.2029 0.4997
Gamma 4 2.0416 2.8743 2.2849 Gamma 4 0.4437 0.2474 0.5045Standard Errors - - - Standard Errors 0.1589 0.1006 0.2403P-values - - - P-values 0.0026 0.0070 0.0179
RQ in sample 25.01 29.27 18.15 RQ in sample 169.30 179.54 105.84RQ out of sample 4.15 5.93 3.65 RQ out of sample 28.48 40.54 22.69
Hits in sample (%) 0.10 0.10 0.14 Hits in sample (%) 1.00 0.97 0.97Hits out of sample (%) 0.00 0.00 0.00 Hits out of sample (%) 1.40 1.60 1.60
DQ in sample (p-values) DQ in sample (p-values)1) [c, hit(-1 to -5)] - - - 1) [c, hit(-1 to -5)] 0.60 0.81 0.562) [VaR] - - - 2) [VaR] 0.98 0.89 0.963) [c, hit(-1), VaR] - - - 3) [c, hit(-1), VaR] 0.96 0.96 0.944) [c, hit(-1 to -5), VaR] - - - 4) [c, hit(-1 to -5), VaR] 0.71 0.88 0.68
DQ out of sample (p-values) DQ out of sample (p-values)1) [c, hit(-1 to -5)] - - - 1) [c, hit(-1 to -5)] 0.96 0.05 0.052) [VaR] - - - 2) [VaR] 0.46 0.21 0.133) [c, hit(-1), VaR] - - - 3) [c, hit(-1), VaR] 0.67 0.53 0.454) [c, hit(-1 to -5), VaR] - - - 4) [c, hit(-1 to -5), VaR] 0.97 0.07 0.07
LM test for VaR(t-2) - - - LM test for VaR(t-2) 0.92 0.92 0.96
54
ASYM SLOPE *** 5% GM IBM S&P 500 ASYM SLOPE *** 25% GM IBM S&P 500Gamma 1 0.0704 0.0951 0.0410 Gamma 1 0.0404 0.0125 0.0014Standard Errors 0.0425 0.0444 0.0221 Standard Errors 0.0298 0.0104 0.0047P-values 0.0488 0.0161 0.0316 P-values 0.0877 0.1151 0.3820
Gamma 2 0.9353 0.8916 0.9026 Gamma 2 0.9132 0.9605 0.9481Standard Errors 0.0222 0.0272 0.0239 Standard Errors 0.0393 0.0169 0.0212P-values 0.0000 0.0000 0.0000 P-values 0.0000 0.0000 0.0000
Gamma 3 0.0411 0.0597 0.0307 Gamma 3 0.0415 0.0108 0.0288Standard Errors 0.0285 0.0335 0.0469 Standard Errors 0.0193 0.0098 0.0192P-values 0.0745 0.0372 0.2565 P-values 0.0157 0.1349 0.0664
Gamma 4 0.1182 0.2110 0.2841 Gamma 4 0.0290 0.0297 0.0288Standard Errors 0.0399 0.0558 0.0895 Standard Errors 0.0170 0.0127 0.0175P-values 0.0015 0.0001 0.0008 P-values 0.0441 0.0097 0.0502
RQ in sample 548.63 515.72 300.76 RQ in sample 1500.88 1360.53 746.90RQ out of sample 99.20 121.05 72.05 RQ out of sample 289.41 311.51 183.48
Hits in sample (%) 4.98 4.91 4.98 Hits in sample (%) 25.00 25.14 24.93Hits out of sample (%) 5.20 7.40 6.80 Hits out of sample (%) 25.60 23.40 25.80
DQ in sample (p-values) DQ in sample (p-values)1) [c, hit(-1 to -5)] 0.83 0.74 0.69 1) [c, hit(-1 to -5)] 0.69 0.83 0.492) [VaR] 0.98 0.87 0.94 2) [VaR] 0.97 0.85 0.933) [c, hit(-1), VaR] 0.97 0.97 0.64 3) [c, hit(-1), VaR] 0.97 0.90 0.994) [c, hit(-1 to -5), VaR] 0.89 0.82 0.74 4) [c, hit(-1 to -5), VaR] 0.79 0.90 0.60
DQ out of sample (p-values) DQ out of sample (p-values)1) [c, hit(-1 to -5)] 0.92 0.03 0.00 1) [c, hit(-1 to -5)] 0.88 0.64 0.292) [VaR] 0.97 0.06 0.20 2) [VaR] 0.88 0.45 0.773) [c, hit(-1), VaR] 0.96 0.00 0.13 3) [c, hit(-1), VaR] 0.67 0.79 0.674) [c, hit(-1 to -5), VaR] 0.95 0.01 0.00 4) [c, hit(-1 to -5), VaR] 0.94 0.70 0.32
LM test for VaR(t-2) 0.96 0.77 0.94 LM test for VaR(t-2) 0.99 0.89 0.60
55
Value at Risk for GM
0
2
4
6
8
10
12
500 1000 1500 2000 2500 3000
A_VAR
0
2
4
6
8
10
12
500 1000 1500 2000 2500 3000
AAV_VAR
0
2
4
6
8
10
12
500 1000 1500 2000 2500 3000
AS_VAR
0
2
4
6
8
10
12
500 1000 1500 2000 2500 3000
G_VAR
0
2
4
6
8
10
12
500 1000 1500 2000 2500 3000
PSA_VAR
0
2
4
6
8
10
12
500 1000 1500 2000 2500 3000
SAV_VAR
56
Value at Risk for SP
-2
0
2
4
6
8
10
12
14
500 1000 1500 2000 2500 3000
A_VAR
0
2
4
6
8
10
12
14
500 1000 1500 2000 2500 3000
AAV_VAR
0
2
4
6
8
10
12
14
500 1000 1500 2000 2500 3000
AS_VAR
0
2
4
6
8
10
12
14
500 1000 1500 2000 2500 3000
G_VAR
0
2
4
6
8
10
12
14
500 1000 1500 2000 2500 3000
PSA_VAR
0
2
4
6
8
10
12
14
500 1000 1500 2000 2500 3000
SAV_VAR
57
58
Dynamic Quantile Test -SPDependent Variable: SAV_HITSample: 5 2892Included observations: 2888Variable Coefficient Std. Error t-Statistic Prob.
C 0.0051 0.0096 0.5277 0.5977SAV_HIT(-1) 0.0397 0.0187 2.1277 0.0334SAV_HIT(-2) 0.0244 0.0187 1.3051 0.1920SAV_HIT(-3) 0.0252 0.0187 1.3468 0.1781SAV_HIT(-4) -0.0044 0.0187 -0.2370 0.8127SAV_VAR -0.0034 0.0066 -0.5241 0.6002
R-squared 0.0029 Mean dependent var 0.0006Adjusted R-squared 0.0012 S.D. dependent var 0.2191S.E. of regression 0.2190 Akaike info criterion -0.1975Sum squared resid 138.2105 Schwarz criterion -0.1851Log likelihood 291.2040 F-statistic 1.7043Durbin-Watson stat 1.9999 Prob(F-statistic) 0.1301
59
In-sample Dynamic Quantile Test
00.10.20.30.40.50.60.70.80.9
1
A_OUT
AAV_
OUT
AS_OUT
G_OUT
PSA_
OUT
SAV_
OUT
GMIBMSP500
60
In-sample 1% Dynamic Quantile Test
00.10.20.30.40.50.60.70.80.9
A_OUT
AAV_
OUT
AS_OUT
G_OUT
PSA_
OUT
SAV_
OUT
GMIBMSP500
61
Out of Sample DQ Test
00.10.20.30.40.50.60.70.80.9
1
A_OUT
AAV_
OUT
AS_OUT
G_OUT
PSA_
OUT
SAV_
OUT
GMIBMSP500
62
Out of Sample 1% DQ Test
00.10.20.30.40.50.60.70.80.9
1
A_OUT
AAV_
OUT
AS_OUT
G_OUT
PSA_
OUT
SAV_
OUT
GMIBMSP500
63
TRADITIONAL GARCH(1,1) : IBM
C 0.133384 0.016911
ARCH(1) 0.112194 0.005075
GARCH(1) 0.851960 0.009923
VaR=1.65*standard deviation
64
DQ TESTS FOR NORMAL GARCH
0
0.05
0.1
0.15
0.2
0.25
IN-SAMPLE IN - TEST2 OUT OUT-TEST2
GMIBMSP500
65
TRADITIONAL GARCH(1,1) : IBM
C 0.133384 0.016911ARCH(1) 0.112194 0.005075GARCH(1) 0.851960 0.009923
5% POINT OF STANDARDIZED RESIDUALS = 1.48
FOR GM THIS POINT IS 1.56FOR S&P THIS POINT IS 1.64
66
DQ TESTS FOR TRADITIONAL GARCH
00.10.20.30.40.50.60.70.80.9
1
IN-SAMPLE IN - TEST2 OUT OUT-TEST2
GMIBMSP500
67
Value at Risk for GM Asymmetric
-30
-20
-10
0
10
20
500 1000 1500 2000 2500 3000
GM -AS_VAR
68
Value at Risk for IBM Adaptive
-30
-20
-10
0
10
20
500 1000 1500 2000 2500 3000
IBM -A_VAR
69
Value at Risk for SP Implicit GARCH
-30
-20
-10
0
10
500 1000 1500 2000 2500 3000
SP500 -G_VAR
70
Some Extensions
• Are there economic variables which can predict tail shapes?
• Would option market variables have predictability for the tails?
• Would variables such as credit spreads prove predictive?
• Can we estimate the expected value of the tail?
71
CONCLUSIONS-Contributions?• Estimation strategy for VaR Models• New Dynamic Specifications of Quantiles• Estimation of VaR without estimating
volatility• Test for VaR accuracy both in and out of
sample• Promising empirical evidence on some
specifications