Dynamic factor value-at-risk for large, heteroskedastic portfolios
AbstractTrading portfolios at Financial institutions are typically driven by a large number of financial variables. These variables are often correlated with each other and exhibit by time-varying volatilities. We propose a computationally efficient Value-at-Risk (VaR) methodology based on Dynamic Factor Models (DFM) that can be applied to portfolios with time-varying weights, and that, unlike the popular Historical Simulation (HS) and Filtered Historical Simulation (FHS) methodologies, can handle time-varying volatilities and correlations for a large set of financial variables. We test the DFM-VaR on three stock portfolios that cover the 2007-2009 financial crisis, and find that it reduces the number and average size of back-testing breaches relative to HS-VaR and FHS-VaR. DFM-VaR also outperforms HS-VaR when applied risk measurement of individual stocks that are exposed to systematic risk.
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Bibliographic InfoPaper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2011-19.
Date of creation: 2011
Date of revision:
Other versions of this item:
- Aramonte, Sirio & Giudice Rodriguez, Marius del & Wu, Jason, 2013. "Dynamic factor Value-at-Risk for large heteroskedastic portfolios," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4299-4309.
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-30 (All new papers)
- NEP-BAN-2011-04-30 (Banking)
- NEP-CMP-2011-04-30 (Computational Economics)
- NEP-ECM-2011-04-30 (Econometrics)
- NEP-RMG-2011-04-30 (Risk Management)
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