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Score-driven Markov-switching EGARCH models: an application to systematic risk analysis

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  • Szabolcs Blazsek
  • Han-Chiang Ho
  • Su-Ping Liu

Abstract

We introduce new Markov-switching (MS) dynamic conditional score (DCS) exponential generalized autoregressive conditional heteroscedasticity (EGARCH) models, to be used by practitioners for forecasting value-at-risk (VaR) and expected shortfall (ES) in systematic risk analysis. We use daily log-return data from the Standard & Poor’s 500 (S&P 500) index for the period 1950–2016. The analysis of the S&P 500 is useful, for example, for investors of (i) well-diversified US equity portfolios; (ii) S&P 500 futures and options traded at Chicago Mercantile Exchange Globex; (iii) exchange traded funds (ETFs) related to the S&P 500. The new MS DCS-EGARCH models are alternatives to of the recent MS Beta-t-EGARCH model that uses the symmetric Student’s t distribution for the error term. For the new models, we use more flexible asymmetric probability distributions for the error term: Skew-Gen-t (skewed generalized t), EGB2 (exponential generalized beta of the second kind) and NIG (normal-inverse Gaussian) distributions. For all MS DCS-EGARCH models, we identify high- and low-volatility periods for the S&P 500. We find that the statistical performance of the new MS DCS-EGARCH models is superior to that of the MS Beta-t-EGARCH model. As a practical application, we perform systematic risk analysis by forecasting VaR and ES.Abbreviation Single regime (SR); Markov-switching (MS); dynamic conditional score (DCS); exponential generalized autoregressive conditional heteroscedasticity (EGARCH); value-at-risk (VaR); expected shortfall (ES); Standard & Poor's 500 (S&P 500); exchange traded funds (ETFs); Skew-Gen-t (skewed generalized t); EGB2 (exponential generalized beta of the second kind); NIG (normal-inverse Gaussian); log-likelihood (LL); standard deviation (SD); partial autocorrelation function (PACF); likelihood-ratio (LR); ordinary least squares (OLS); heteroscedasticity and autocorrelation consistent (HAC); Akaike information criterion (AIC); Bayesian information criterion (BIC); Hannan-Quinn criterion (HQC).

Suggested Citation

  • Szabolcs Blazsek & Han-Chiang Ho & Su-Ping Liu, 2018. "Score-driven Markov-switching EGARCH models: an application to systematic risk analysis," Applied Economics, Taylor & Francis Journals, vol. 50(56), pages 6047-6060, December.
    • Handle: RePEc:taf:applec:v:50:y:2018:i:56:p:6047-6060
    DOI: 10.1080/00036846.2018.1488073
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    Citations

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    Cited by:

    1. Chang, Kuang-Liang, 2023. "The low-magnitude and high-magnitude asymmetries in tail dependence structures in international equity markets and the role of bilateral exchange rate," Journal of International Money and Finance, Elsevier, vol. 133(C).
    2. Astrid Ayala & Szabolcs Blazsek, 2019. "Score-driven currency exchange rate seasonality as applied to the Guatemalan Quetzal/US Dollar," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 10(1), pages 65-92, March.
    3. Astrid Ayala & Szabolcs Blazsek & Adrian Licht, 2022. "Score-driven stochastic seasonality of the Russian rouble: an application case study for the period of 1999 to 2020," Empirical Economics, Springer, vol. 62(5), pages 2179-2203, May.
    4. Blazsek, Szabolcs & Escribano, Álvaro & Licht, Adrian, 2019. "Markov-switching score-driven multivariate models: outlier-robust measurement of the relationships between world crude oil production and US industrial production," UC3M Working papers. Economics 29030, Universidad Carlos III de Madrid. Departamento de Economía.
    5. Shaojie Liu & Jing Teng & Yue Gong, 2020. "Extraction Method and Integration Framework for Perception Features of Public Opinion in Transportation," Sustainability, MDPI, vol. 13(1), pages 1-17, December.
    6. Alanya-Beltran Willy, 2023. "Modelling volatility dependence with score copula models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 27(5), pages 649-668, December.
    7. Ayala Astrid & Blazsek Szabolcs & Escribano Alvaro, 2023. "Anticipating extreme losses using score-driven shape filters," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 27(4), pages 449-484, September.
    8. Ayala, Astrid & Blazsek, Szabolcs & Escribano, Álvaro, 2019. "Score-driven time series models with dynamic shape : an application to the Standard & Poor's 500 index," UC3M Working papers. Economics 28133, Universidad Carlos III de Madrid. Departamento de Economía.
    9. Blazsek, Szabolcs & Escribano, Álvaro & Licht, Adrian, 2018. "Seasonality Detection in Small Samples using Score-Driven Nonlinear Multivariate Dynamic Location Models," UC3M Working papers. Economics 27483, Universidad Carlos III de Madrid. Departamento de Economía.
    10. Ayala, Astrid & Blazsek, Szabolcs & Escribano, Álvaro, 2019. "Maximum likelihood estimation of score-driven models with dynamic shape parameters : an application to Monte Carlo value-at-risk," UC3M Working papers. Economics 28638, Universidad Carlos III de Madrid. Departamento de Economía.

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