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CHICAGO: A Fast and Accurate Method for Portfolio Risk Calculation

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  • Simon A. Broda
  • Marc S. Paolella

Abstract

This paper shows how independent component analysis can be used to estimate the generalized orthogonal GARCH model in a fraction of the time otherwise required. The proposed method is a two-step procedure, separating the estimation of the correlation structure from that of the univariate dynamics, thus facilitating the incorporation of non-Gaussian innovations distributions in a straightforward manner. The generalized hyperbolic distribution provides an excellent parametric description of financial returns data and is used for the univariate fits, but its convolutions, necessary for portfolio risk calculations, are intractable. This restriction is overcome by saddlepoint approximations for the Value at Risk and expected shortfall, which are computationally cheap and retain excellent accuracy far into the tails. It is further shown that the mean-expected shortfall portfolio optimization problem can be solved efficiently in the context of the model. A simulation study and an application to stock returns demonstrate the validity of the procedure. Copyright The Author 2009. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

Suggested Citation

  • Simon A. Broda & Marc S. Paolella, 2009. "CHICAGO: A Fast and Accurate Method for Portfolio Risk Calculation," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 7(4), pages 412-436, Fall.
  • Handle: RePEc:oup:jfinec:v:7:y:2009:i:4:p:412-436
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbp011
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    Cited by:

    1. Broda, Simon A. & Haas, Markus & Krause, Jochen & Paolella, Marc S. & Steude, Sven C., 2013. "Stable mixture GARCH models," Journal of Econometrics, Elsevier, vol. 172(2), pages 292-306.
    2. Alp, Tansel & Demetrescu, Matei, 2010. "Joint forecasts of Dow Jones stocks under general multivariate loss function," Computational Statistics & Data Analysis, Elsevier, vol. 54(11), pages 2360-2371, November.
    3. Alexios Ghalanos & Eduardo Rossi & Giovanni Urga, 2015. "Independent Factor Autoregressive Conditional Density Model," Econometric Reviews, Taylor & Francis Journals, vol. 34(5), pages 594-616, May.
    4. Zolotko, Mikhail & Okhrin, Ostap, 2014. "Modelling the general dependence between commodity forward curves," Energy Economics, Elsevier, vol. 43(C), pages 284-296.
    5. Basher, Syed Abul & Sadorsky, Perry, 2016. "Hedging emerging market stock prices with oil, gold, VIX, and bonds: A comparison between DCC, ADCC and GO-GARCH," Energy Economics, Elsevier, vol. 54(C), pages 235-247.
    6. repec:gam:jecnmx:v:5:y:2017:i:2:p:18-:d:97715 is not listed on IDEAS
    7. Slim, Skander & Koubaa, Yosra & BenSaïda, Ahmed, 2017. "Value-at-Risk under Lévy GARCH models: Evidence from global stock markets," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 46(C), pages 30-53.
    8. Marc S. Paolella, 2016. "Stable-GARCH Models for Financial Returns: Fast Estimation and Tests for Stability," Econometrics, MDPI, Open Access Journal, vol. 4(2), pages 1-28, May.
    9. Michele Leonardo Bianchi & Gian Luca Tassinari & Frank J. Fabozzi, 2016. "Riding With The Four Horsemen And The Multivariate Normal Tempered Stable Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(04), pages 1-28, June.
    10. Fajardo, José & Farias, Aquiles, 2010. "Derivative pricing using multivariate affine generalized hyperbolic distributions," Journal of Banking & Finance, Elsevier, vol. 34(7), pages 1607-1617, July.
    11. Haas, Markus & Krause, Jochen & Paolella, Marc S. & Steude, Sven C., 2013. "Time-varying mixture GARCH models and asymmetric volatility," The North American Journal of Economics and Finance, Elsevier, vol. 26(C), pages 602-623.
    12. Matilainen, Markus & Nordhausen, Klaus & Oja, Hannu, 2015. "New independent component analysis tools for time series," Statistics & Probability Letters, Elsevier, vol. 105(C), pages 80-87.
    13. repec:eee:ecmode:v:72:y:2018:i:c:p:278-295 is not listed on IDEAS
    14. Paolella, Marc S., 2017. "Asymmetric stable Paretian distribution testing," Econometrics and Statistics, Elsevier, vol. 1(C), pages 19-39.

    More about this item

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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