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Backtesting an equity risk model under Solvency II

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  • Durán Santomil, Pablo
  • Otero González, Luís
  • Martorell Cunill, Onofre
  • Merigó Lindahl, José M.

Abstract

Backtesting is a technique for validating internal models under Solvency II, which allows for evaluating the discrepancies between the results provided by a model and real observations. This paper aims to establish various backtesting tests and to show their applications to equity risk in Solvency II. Normal and empirical models with a rolling window are used to determine VaR at the 99.5% confidence level over a one-year time horizon. The proposed methodology performs the backtesting of annualized returns arising from the accumulation of daily returns. The results show that even if a model is conservative when tested out of a sample, it may be inadequate when evaluated in a sample, thereby highlighting the problems inherent in the out-of-sample backtesting proposed by the regulator.

Suggested Citation

  • Durán Santomil, Pablo & Otero González, Luís & Martorell Cunill, Onofre & Merigó Lindahl, José M., 2018. "Backtesting an equity risk model under Solvency II," Journal of Business Research, Elsevier, vol. 89(C), pages 216-222.
    • Handle: RePEc:eee:jbrese:v:89:y:2018:i:c:p:216-222
    DOI: 10.1016/j.jbusres.2018.01.004
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    References listed on IDEAS

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    1. Santanu Dutta & Tushar Kanti Powdel, 2023. "Modeling Long Term Return Distribution and Nonparametric Market Risk Estimation," Sankhya B: The Indian Journal of Statistics, Springer;Indian Statistical Institute, vol. 85(1), pages 257-289, May.

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