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Spectral Backtests of Forecast Distributions with Application to Risk Management

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Abstract

We study a class of backtests for forecast distributions in which the test statistic is a spectral transformation that weights exceedance events by a function of the modeled probability level. The choice of the kernel function makes explicit the user's priorities for model performance. The class of spectral backtests includes tests of unconditional coverage and tests of conditional coverage. We show how the class embeds a wide variety of backtests in the existing literature, and propose novel variants as well. In an empirical application, we backtest forecast distributions for the overnight P&L of ten bank trading portfolios. For some portfolios, test results depend materially on the choice of kernel.

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  • Michael B. Gordy & Alexander J. McNeil, 2018. "Spectral Backtests of Forecast Distributions with Application to Risk Management," Finance and Economics Discussion Series 2018-021, Board of Governors of the Federal Reserve System (U.S.).
  • Handle: RePEc:fip:fedgfe:2018-21
    DOI: 10.17016/FEDS.2018.021
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    Cited by:

    1. Alexander J. McNeil, 2020. "Modelling volatile time series with v-transforms and copulas," Papers 2002.10135, arXiv.org, revised Jan 2021.
    2. Nick Costanzino & Michael Curran, 2018. "A Simple Traffic Light Approach to Backtesting Expected Shortfall," Risks, MDPI, Open Access Journal, vol. 6(1), pages 1-7, January.

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    More about this item

    Keywords

    Backtesting; Risk management; Volatility;
    All these keywords.

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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