QBUS6830 (S2, 2022); Module 4; 1

Module 4: Forecasting and Risk Management

References:
• Chapters 3 (forecasting) and 7 (Value at Risk) in Tsay
• Chapters 1, 2 and 6 in McNeil, Frey and Embrechts
• Wong CM & So MKP (2003) “On Conditional Moments of GARCH models, with
applications to multiple period Value at Risk estimation”, Statistica Sinica, 13,
1015-1044.
QBUS6830 (S2, 2022); Module 4; 2

Section 4.1: Multiple-step-ahead h > 1 tail risk forecasting

• We now consider h > 1. Recall that Basel II recommends h = 10 for VaR, ES
(tail risk) forecasting.

• Under a dynamic volatility model:

2
rt+1|Ft ∼ D(µt+1, σt+1 )
i.e. ϵt ∼ iid D(0, 1).

• However, for h > 1 the distribution of rt+h|Ft is not D, under the volatility
models we have considered.

• However, the mean and variance of rt+h|Ft are given by the formulas we know
(and can derive) for: µt(h), σt2(h)

• For example, if ϵt ∼ iid N (0, 1), it is not hard to show that, for h > 1, the kurtosis
QBUS6830 (S2, 2022); Module 4; 3

of rt+h|Ft is greater than 3, under any ARCH/GARCH model.

• Hence rt+h|Ft is not distributed as a Gaussian in this case.

• Further, if rt+1|Ft ∼ D(µt+1, σt+1

2
), then the conditional forecast distribution of
h
X h
X
rt[h]|Ft = rt+k |Ft = rt(k)
k=1 k=1

is also not D.

• Wong and So (2003) proved these results (for D ≡ N ) in a lovely paper on

conditional moments for GARCH moments.

• Please note that the Gaussian-based formulas for h > 1 for tail risk in Tsay’s
textbook are thus incorrect.
QBUS6830 (S2, 2022); Module 4; 4

• Figure 1 shows a plot from Wong and So (2003) illustrating this point.

Figure 1: Kurtosis for rt+h |Ft and rt [h]|Ft for GARCH(1,1) models
QBUS6830 (S2, 2022); Module 4; 5

• As such, the approximation (as in Tsay):

rt[h]|Ft ≈ D(µt[h], σt2[h])
will usually lead to under-estimation, (i.e. risky) of VaR levels via:
q
VaRp(h) ≈ D−1(p) σt2[h] + µt[h]
for h > 1.

• Note that, in general:

µt[h] = E(rt[h]|Ft)
Xh
= µt(h)
k=1
σt2[h] = V ar(rt[h]|Ft)
Xh h X
X
= σt2(h) + 2 Cov(rt+k , rt+j |Ft)
k=1 k=1 j<k
where the covariance terms are exactly 0 under a constant mean µt = µ model.
QBUS6830 (S2, 2022); Module 4; 6

Ph
• i.e. if µt = µ (constant mean) then σt2[h] = 2
k=1 σt (h).

• To estimate the true distribution for rt[h]|Ft, h > 1 and associated tail risk
measures for the model being fit to the data, Monte Carlo sampling is used to
implicitly, sample from the distribution of rt[h]|Ft, by repeatedly sampling from
the 1-step-ahead distribution, ...

• ... even though we do not know exactly what distribution rt[h]|Ft follows; we
can use probability theory to use successive h = 1 forecasting to achieve this. We
consider this aspect below in more detail.

4.1(a) Monte Carlo simulation for VaR and ES (h > 1)

• Dynamic volatility models, as usually specified, do not allow knowledge of the
distribution of either rt+h|Ft, or the h-day return rt[h]|Ft, for h > 1.
QBUS6830 (S2, 2022); Module 4; 7

• However, since the GARCH is a fully parametric model, we can simulate from
BOTH these distributions implicitly, by repeatedly using the implied 1-step-ahead
distribution rt+1|Ft, using a neat probability trick.

• As an e.g., consider an AR(1)-GARCH(1,1) process:

rt = µt + at
σt2 = α0 + α1a2t−1 + β1σt−1
2

where µt = ϕ0 + ϕ1rt−1, at = σtϵt and

ϵt ≡ i.i.d. D(0, 1)

• We wish to obtain information about the distribution of rt[h]|Ft for h > 1.

• Monte Carlo (MC) simulation is used as follows.

• We obtain many MC samples from the joint distribution for rt+1, rt+2, . . . , rt+h|Ft.
QBUS6830 (S2, 2022); Module 4; 8

• We then add these realisations of rt+1, rt+2, . . . , rt+h|Ft together to achieve a single
simulated sample from rt[h]|Ft (from the model being that simulated from).

• A single sample from the distribution rt[h]|Ft can be simulated as follows:

2
1. Use the current parameter estimates to calculate σt+1 |Ft and µt+1|Ft, both of
which are considered known, e.g. from the GARCH(1,1) and AR(1) equations
above.
2. Simulate a single r.v. ϵt+1 ∼ D(0, 1).
3. Calculate at+1 = ϵt+1σt+1, then form rt+1 = µt+1 + at+1. This is a single
observation sampled from p(rt+1|Ft).
2
4. Using this simulated value, calculate σt+2 |rt+1, Ft and µt+2|rt+1, Ft, i.e. by
using the at+1 and rt+1 just simulated in the GARCH(1,1) and AR(1) equations
above.
5. Simulate a single r.v. ϵt+2 ∼ D(0, 1).
QBUS6830 (S2, 2022); Module 4; 9

6. Calculate at+2 = ϵt+2σt+2, then form rt+2 = µt+2 + at+2. This is a sample from
p(rt+2|rt+1, Ft).
7. Repeat steps 4, 5, and 6 using j = 3, 4, . . . , h − 1, instead of j = 2: i.e. for
j = 3, 4, . . . , h − 1:
2
8. calculate σt+j |rt+j−1, Ft and µt+j |rt+j−1, Ft, i.e. by using the at+j−1 and rt+j−1
just simulated and the GARCH and AR equations above.
9. Finally, for j = h:
2
10. Calculate µt+h, σt+h |rt+1, . . . , rt+h−1, Ft, using the rt+1, . . . , rt+h−1 simulated
in steps 1-7 above.
11. Simulate a single ϵt+h ∼ D(0, 1)
12. Form at+h = ϵt+hσt+h, then form rt+h = µt+h + at+h, which is a sample from
p(rt+h|rt+1, . . . , rt+h−1, Ft).
13. Finally, form rt[h]|Ft by summing up the single realization of the h values
QBUS6830 (S2, 2022); Module 4; 10

Ph
rt+1, . . . , rt+h|Ft just simulated, i.e. rt[h]|Ft = j=1 rt+j |Ft .

14. Repeat all steps above many times, forming a MC sample from rt[h]|Ft

• Repeating these steps many times will provide a Monte Carlo sample from the
distribution rt[h]|Ft.

• How does this achieve a single realisation or sample from the joint distribution for
rt+1, rt+2, . . . , rt+h|Ft??

• Consider h = 2. Also recall that p(rt+1, rt+2|Ft) = p(rt+1|Ft)p(rt+2|rt+1, Ft)

• i.e. to simulate from rt[2]|Ft = rt+1+rt+2|Ft requires sampling from p(rt+1, rt+2|Ft)

• but this is equivalent to simulating from p(rt+1|Ft) and then p(rt+2|rt+1, Ft).
QBUS6830 (S2, 2022); Module 4; 11

• The h-step-ahead VaR forecast is then the relevant sample quantile of this forecast
sample of h-period returns.

• The h-step-ahead ES is simply the sample mean of the h-period returns beyond
the VaR estimate.

• This is not hard to code (e.g. in Python). But can take a longish time to run.

• Monte Carlo sampling variation (what is this??) can be reduced by taking a

large number of MC samples, i.e. repeating steps 1-13 above many, many times.
QBUS6830 (S2, 2022); Module 4; 12

Section 4.1(b): Example

• Consider forecasting the 10 day ahead return distribution at the end of the sample
for CBA, i.e. from 21st October, 2022.

• We consider an AR-GJR-GARCH model, with Gaussian and Student-t errors, to

provide VaRs at p = 0.025 and p = 0.01 (and others) for h = 10.

• For h = 10 I used 100000 Monte Carlo simulations of rt[10]|Ft

• I obtained, under Gaussian (Student-t) errors: VaR10;0.025 = −7.45% (−7.18%)

and VaR10;0.01 = −9.48% (−9.26%).
QBUS6830 (S2, 2022); Module 4; 13

• Figure 2 shows a histogram of 100000 simulated 10 day returns rt[10]|Ft under

Gaussian errors.

Figure 2: Histogram of 100000 Monte Carlo forecasted 10-day returns from AR-GJR-GARCH-N model. T is the end of the full sample.
QBUS6830 (S2, 2022); Module 4; 14

• The VaRs are the sample percentiles of this Monte Carlo sample, and the ES
estimates are the sample means for those simulated 10 day returns beyond the
VaR limits.
QBUS6830 (S2, 2022); Module 4; 15

• Figure 3 shows a histogram of 100000 simulated 10 day returns rh[10] under

Student-t errors.

Figure 3: Histogram of 100000 Monte Carlo forecasted 10-day returns from AR-GJR-GARCH-t model. T is the end of the full sample.
QBUS6830 (S2, 2022); Module 4; 16

• Fatter tails are only slightly more apparent under the Student-t model, though
the very few outliers, compared to a Gaussian, are clear.

• For the Gaussian error model, the sample skewness and kurtosis for rt[10] are
−0.26, 3.77 respectively.

• A Jarque-Bera test confirms these are not consistent with a Gaussian distribution,
with p-val ≈ 0.0.

• For the Student-t GJR model, the sample skewness and kurtosis for rt[10] are
−0.21, 4.06 respectively.

• A Jarque-Bera test again confirms these are both not consistent with a Gaussian
distribution, with p-value 0.0.
QBUS6830 (S2, 2022); Module 4; 17

• The outliers in the Student-t error based model have led to higher kurtosis for the
10-day returns than for the Gaussian error model.

• The table below shows estimates of VaR10 and ES10 for a range of levels p for the
GJR and GJR-t models.
Table 1: 10 day tail risk VaR (h = 10) forecasts for CBA

Risk measure p 0.1 0.05 0.025 0.01 0.005

VaR GJR -4.30 -5.91 -7.45 -9.48 -11.00
GJR-t -4.03 -5.63 -7.18 -9.26 -10.92
ES GJR -6.58 -8.13 -9.67 -11.70 -13.25
GJR-t -6.32 -7.90 -9.49 -11.63 -13.24

• The Gaussian error model gives more extreme 10-day VaR forecasts for p ≥ 0.025,
compared to the Student-t model.

• For p ≤ 0.025, as we move further out into the tails, the Student-t error model
QBUS6830 (S2, 2022); Module 4; 18

gives more extreme 10-day VaR and ES forecasts for rt[10]|Ft.

• The Gaussian and Student-t error models give more similar 10-day ES forecasts,
than they did for 10-day VaR, as also occurs as p gets smaller; overall these
differences seem relatively less important (compared to those for h = 1 say).

• The 10-day CBA return distribution, from 04/05/22, has risk levels between 4%
and 13%, depending on p.

• The 10-day 1% VaR is ≈ 9.4%, whilst the 10 day 2.5% ES is ≈ 9.6%, the 10 day
1% ES is ≈ 11.6%
QBUS6830 (S2, 2022); Module 4; 19

(4.1c) RiskMetrics, h > 1

• The RiskMetrics IGARCH model is:
rt = at
σt2 = (1 − β)a2t−1 + βσt−1
2

where at ∼ N (0, σt2) and β = 0.94 for daily data.

• For any h > 1, the general IGARCH model has

σt2(h) = σt2(h − 1) ; µt(h) = 0

• Thus the single day forecast variance remains exactly the same for any forecast
horizon h (i.e. no mean reversion).
QBUS6830 (S2, 2022); Module 4; 20

• So, for any h > 0, σt2(h) = σt2(1) and:

h
X
µt[h] = µt(h) = 0
k=1
Xh
σt2[h] = σt2(h)
k=1
= hσt2(1)

Ph
• Riskmetrics incorrectly assumes that k=1 rt+h |Ft ∼ N (0, hσt2(1)) and for any
horizon h > 0 employs:
q
VaRp(h) = Φ−1(p) hσt2(1)
√ −1


ϕ Φ (p)
ESp(h) = − hσt(1)
p
which, in truth, are only approximations, and likely risky, anti-conservative ones
at that.
QBUS6830 (S2, 2022); Module 4; 21

• This approximate method should under-estimate the true VaR for h > 1, by
Wong and So (2003), since they showed fatter tails than Gaussian for h > 1.

• We can however, also get more ”correct” estimates by using MC simulation for
the RM model, in the same way as we do for GARCH models.

• Under a simpler model, if rt ∼ i.i.d N (µ, σ 2) then:

h
X
rt[h]|Ft = rt+h|Ft ∼ N (hµ, hσ 2)
k=1

and
√
−1
VaRp(h) = Φ (p) hσ 2 + hµ
√ ϕ Φ−1(p)


ESp(h) = hµ − hσ
p
QBUS6830 (S2, 2022); Module 4; 22

• An historical simulation (HS) approach for h > 1 would be to set

VaRp(h) = Fh−1(p) = r̂[h](p)
ESp(h) = r̄ (I(rt[h] < VaRp(h)))
which is the empirical 100pth percentile of the h period return series rt[h] =
Pt+h
k=t+1 rk , and its’ conditional sample mean.

• The series rt[h] is again usually chosen to be non-overlapping; which reduces our
sample size to Th .

• When h = 10, this is a series of 10 day returns and our sample size is divided by
10

• CAViaR can also be employed directly on the h-day returns, but this is not often
done since Th is usually not large enough for accurate estimate of the CaViaR
model.
QBUS6830 (S2, 2022); Module 4; 23

• There is currently little work on using the 1-day CAViaR VaR model to find an
h-day VaR (or ES) forecast.
Section (4d): Example
• Figure 16 shows the non-overlapping 10 day CBA returns.

• Figure 5 shows the non-overlapping 10 day CBA returns in the forecast period
only.

• Note the much ”shorter” effect of Covid in March 2020 on 10 day CBA returns,
compared to the 1-day returns.

• And the far lower degree of persistence in volatility compared to 1-day returns.

• I now forecast VaR and ES for the non-overlapping 10 day returns for CBA, after
20th Dec, 2007. This gives 375 non-overlapping 10-day returns to forecast.
QBUS6830 (S2, 2022); Module 4; 24

CBA 10-day non-overlapping returns: 2000-2022

20

10

10

20

30

2000 2004 2008 2012 2016 2020

Figure 4: 10 day non-overlapping returns for CBA, 2000-2022

• It allows an in-sample period of T = 2015 returns to estimate the formal models.

QBUS6830 (S2, 2022); Module 4; 25

20

10

10

20

30 CBA 10-day non-overlapping returns: forecast period

2008 2010 2012 2014 2016 2018 2020 2022

Figure 5: 10 day non-overlapping returns for CBA, from 8th Dec, 2009

• I use the ARCH(5), GARCH, GJR and EGARCH models, all with both Gaus-
sian and Student-t errors, plus the RiskMetrics model (both by simulation and
QBUS6830 (S2, 2022); Module 4; 26

Gaussian assumption), for daily data and generate 10 day ahead forecasts of rt[10].

• I estimate the models using daily data previous to the 10 day period being
forecast, re-estimating all models for each new 10-day forecast.

• I use MC sample size 50000.

• Figure 6 shows the VaR10 and ES10 forecasts at p = 0.025 for the EGARCH-t
and RiskMetrics models (both using simulation).

• The two VaR and ES series are fairly close to each other, though often the EG-t
model gives slightly more extreme forecasts.

• Except for during the high volatility period, where RM gives the most extreme
forecasts, both during and for several 10 day periods after it.
QBUS6830 (S2, 2022); Module 4; 27

20

10

10

20

30 CBA 10-day returns

2.5% VaR EG-t
2.5% ES EG-t
40 VaR RM
ES RM
2008 2010 2012 2014 2016 2018 2020 2022

Figure 6: 10 day non-overlapping returns for CBA plus forecasts of VaR10 and ES10 at p = 0.025 for the EGARCH-t and RiskMetrics
models.

• Figure 7 shows the VaR10 and ES10 forecasts at p = 0.025 for the RM Gaussian
and HS models.
QBUS6830 (S2, 2022); Module 4; 28

20

10

10

20
CBA 10-day returns
VaR HS100
30 ES HS100
2.5% VaR HS-T
2.5% ES HS-T
VaR RM N
40 ES RM N
2008 2010 2012 2014 2016 2018 2020 2022

Figure 7: 10 day non-overlapping returns for CBA plus forecasts of VaR10 and ES10 at p = 0.025 for the informal, adhoc methods.

• Figure 8 shows the VaR10 and ES10 forecasts at p = 0.01 for the GJR-GARCH-t
and ARCH-t models (both using simulation).
QBUS6830 (S2, 2022); Module 4; 29

20

20

40

CBA 10-day returns

1% VaR GJR-t
1% ES GJR-t
60 1% VaR A-t
1% ES A-t
2008 2010 2012 2014 2016 2018 2020 2022

Figure 8: 10 day non-overlapping returns for CBA plus forecasts of VaR10 and ES10 at p = 0.01 for GJR-t and ARCH-t models.

• Figure 9 shows the VaR10 and ES10 forecasts at p = 0.01 for the adhoc HS
methods, plus the (incorrect) RiskMetrics method assuming 10-day returns are
QBUS6830 (S2, 2022); Module 4; 30

Gaussian.

20

10

10

20
CBA 10-day returns
30 VaR HS100
ES HS100
1% VaR HS-T
40 1% ES HS-T
VaR RM N
ES RM N
50
2008 2010 2012 2014 2016 2018 2020 2022

Figure 9: 10 day non-overlapping returns for CBA plus forecasts of VaR10 and ES10 at p = 0.01 for RiskMetrics (Gaussian), HS-100 and
HS-T.
QBUS6830 (S2, 2022); Module 4; 31

• The table below shows accuracy measures for p = 0.025 over the 360 10-day
periods for VaR forecasts for CBA.
Table 2: The 10-step-ahead forecast VaR summary for all models for CBA, p = 0.025.

Model A G GJR EG RM A-t G-t

Viols (9-10) 12 18 15 15 16 11 18
VRate (0.025) 0.032 0.048 0.040 0.040 0.043 0.029 0.048
Ratio 1.28 1.92 1.60 1.60 1.71 1.17 1.92
p-valU C 0.385 0.004 0.063 0.063 0.028 0.591 0.004
p-valind 0.3229 0.825 0.648 0.482 0.286 0.362 0.825
p-valDQ 0.042 0.039 0.183 0.348 0.174 0.042 0.039
Q loss 147.74 160.13 152.49 154.55 159.51 147.80 162.67
GJR-t EG-t RM N iid N HS-100 HS-T
Viols (9) 15 15 18 14 13 16
VRate (0.025) 0.040 0.040 0.048 0.037 0.035 0.043
Ratio 1.60 1.60 1.92 1.49 1.39 1.71
p-valU C 0.063 0.063 0.004 0.126 0.231 0.028
p-valind 0.623 0.623 0.266 0.097 0.071 0.026
p-valDQ 0.448 0.441 0.009 0.000 0.001 0.000
Q loss 157.04 156.73 167.03 179.40 192.31 179.70

• At p = 0.025, the 10-step-ahead forecasts for VaR are most accurate in VRate
QBUS6830 (S2, 2022); Module 4; 32

for the ARCH-t method: this method also passes most tests but fails the DQ test
(p = 0.042).

• The 3 best methods by VRate are the ARCH-t, ARCH-N and HS-100. The
ARCH-t and ARCH-N have the 2 lowest quantile values, whilst the HS-100 has
the worst/highest quantile loss. These models also all fail the DQ test.

• The UC test rejects the GARCH, RM, GARCH-t, GJR-t and HS-T models,
indicating these all have violation rates significantly different to (higher than) the
desired 2.5%.

• The incorrect RM N model (18) has 2 more violations than the simulation-based
RM model (16). Both are rejected by the UC test.

• The Independence test only rejects the HS-T method.

QBUS6830 (S2, 2022); Module 4; 33

• The DQ test using 4 lags rejects the ARCH, GARCH, ARCH-t, GARCH-t, RM-
N, iid N, HS-100 and HS-T models as having inaccurate 2.5% VaR forecasts and
likely VaR violations correlated with quantile forecast and/or previous violations.

• Only the GJR-GARCH-N, EGARCH-N, RM, GJR-t and EGARCH-t are not
rejected by the DQ test.

• For models not rejected by any test, the quantile loss function values GJR-N and
EGARCH-N models.

• The iid N, HS-100 and HS-T models rank in the 3 last places by the loss function.

• For VaR 10-step forecasts at p = 0.025, the GJR-N model is the best performing
model overall, followed closely by the EGARCH-N model.
QBUS6830 (S2, 2022); Module 4; 34

• Figure 10 shows 2.5% VaR violations for the ARCH-N, GJR-GARCH-N, HS-T
and RM methods.

• Clearly the HS-T has correlated and clustered violations, whilst the RM has too
many violations.

• For ES 10-step ahead forecasting at p = 0.025, we might expect ESRates close to

and inside, the range (Student-t) 0.008-0.0096 (Gaussian), i.e. ≈ 3 − 4 violations
on average.

• The ARCH-t and HS-100 models are closest to what we expect here, with 5
violations each. But most other models seem quite inadequate by ES violation
rate; e.g. many have ES VRate ≥ 0.025, ≥ 9 violations, except ARCH-N and
HS-T.
QBUS6830 (S2, 2022); Module 4; 35

20

10

10

20
CBA 10-day returns and 2.5% violations
ARCH-N
GJR
30 HS-T
RM
2008 2010 2012 2014 2016 2018 2020 2022

Figure 10: 10 day returns for CBA plus 2.5% VaR10 violations for some models.

• The t-test on the standardised ES residuals finds that the ES forecast residuals
are not significantly different to a mean of 0 for most of the models: i.e. we can’t
QBUS6830 (S2, 2022); Module 4; 36

Table 3: The 10-step-ahead forecast ES summary for all models for CBA, p = 0.025.

Model A G GJR EG RM A-t G-t

ES viols (3-4?) 6 12 10 11 12 5 12
Mean ξ -2.63 -2.99 -2.52 -2.78 -3.13 -2.48 -2.95
t-stat ξ -1.31 -2.59 -1.84 -2.06 -2.86 -1.12 -2.56
Mean ξs -0.70 -0.70 -0.66 -0.68 -0.77 -0.71 -0.69
t-stat ξs -1.32 -2.53 -1.83 -1.98 -2.87 -1.26 -2.41
p-val 0.21 0.02 0.09 0.07 0.01 0.24 0.03
Joint loss 3.84 4.03 3.89 3.91 3.97 3.83 4.05
RMSE ξ 7.14 5.62 5.71 5.75 5.28 7.40 5.60
MAD ξ 5.16 3.41 3.31 3.54 3.53 5.59 3.50
GJR-t EG-t RM N iid N HS-100 HS-T
ES viols (3-4?) 11 11 13 11 5 6
Mean ξ -2.76 -2.84 -3.45 -5.48 -4.09 -1.33
t-stat ξ -2.07 -2.18 -3.10 -2.61 -1.75 -0.59
Mean ξs -0.70 -0.72 -0.88 -1.53 -1.29 -0.54
t-stat ξs -1.83 -2.06 -3.41 -2.60 -1.86 -0.89
p-val 0.09 0.06 0.00 0.02 0.09 0.39
Joint loss 3.95 3.95 4.13 4.45 4.61 4.31
RMSE ξ 5.70 5.65 5.74 9.34 9.06 8.84
MAD ξ 3.33 3.60 3.86 6.05 6.22 6.80

reject any of the ES forecast models as being biased at p = 0.025; the models
rejected are GARCH-N, RM, GARCH-t, RM N and iid N (p < 0.05).
QBUS6830 (S2, 2022); Module 4; 37

• The HS-T model’s 2.5% ES residuals and standardised residuals are closest in
mean to 0 and in their t-stats closest to 0 and highest p-values.

• The RM model’s 2.5% ES residuals have the lowest RMSE, while the GJR-N’s
have the lowest MAD; these 2 models have 2.5% ES residuals closest to 0 in
variation.

• The RM-N has the highest number of 2.5% ES violations (13), which is higher than
what the 2.5% VaR violation number should be, and thus is highly problematic.

• The model with VaR and ES forecasts having the lowest joint VaR and ES loss
value is the ARCH-t, closely followed by the ARCH-N model.

• The 3 models with clearly highest joint loss values, as well as clearly highest RMSE
and MAD values, are again: HS-100, iid N and HS-T.
QBUS6830 (S2, 2022); Module 4; 38

• At p = 0.025, the ARCH-t and ARCH-N models appear to be the most accurate
forecasters of ES and joint forecasters of 10-day VaR and ES levels, for CBA.

• Figures 11 and 12 show the forecast ES10 residuals for some models for their ES
2.5% forecasts.

• Again we see the property of ES residuals that they are negatively skewed, are
mostly small and positive but also tend to have a few larger magnitude, negative
values.

• The models shown have between 11 and 18 VaR 2.5% violations, thus they also
have from 11-18 ES 2.5% residuals.

• The models shown seem to have close to mean 0 ES 2.5% residuals, but differing
variation levels, agreeing with the ES 2.5% table above.
QBUS6830 (S2, 2022); Module 4; 39

5 ARCH
ARCH-t
EG-t
RM
GARCH-t
0 GJR-GARCH

10

15

0.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5

Figure 11: Forecast residuals for ES10 (p = 0.025): ξt , for ARCH, GJR-GARCH-N, ARCH-t, EGARCH-t, GARCH-t and RiskMetrics.

• The table below shows accuracy measures for p = 0.01 over the 375 10-day periods
for VaR forecasts.
QBUS6830 (S2, 2022); Module 4; 40

10

15
RM N
HS-100
20 HS-T
GARCH-N
0.0 2.5 5.0 7.5 10.0 12.5 15.0 17.5

Figure 12: Forecast residuals for ES10 (p = 0.025): ξt , for RM Gaussian, HS-100 and HS-T.

• At p = 0.01, the 10-step-ahead forecasts for VaR are most accurate in VRate for
the ARCH-t model, with 5 violations and V Rate = 0.013.
QBUS6830 (S2, 2022); Module 4; 41

Table 4: The 10-step-ahead forecast VaR summary for all models for CBA, p = 0.01.

Model A G GJR EG RM A-t G-t

Viols (3-4) 6 13 10 11 12 5 12
VRate (0.01) 0.016 0.035 0.027 0.029 0.032 0.013 0.032
Ratio 1.600 3.467 2.667 2.933 3.200 1.333 3.200
p-valU C 0.243 0.000 0.001 0.000 0.000 0.517 0.000
p-valind 0.075 0.462 0.458 0.319 0.388 0.048 0.388
p-valDQ 0.003 0.000 0.115 0.005 0.001 0.000 0.001
Q loss 89.85 96.15 85.56 89.40 94.16 88.81 98.09
GJR-t EG-t RM N iid N HS-100 HS-T
Viols (3-4) 11 11 13 11 7 8
VRate (0.01) 0.029 0.029 0.035 0.029 0.019 0.021
Ratio 2.933 2.933 3.467 2.933 1.867 2.133
p-valU C 0.000 0.000 0.000 0.000 0.092 0.027
p-valind 0.319 0.319 0.462 0.034 0.110 0.152
p-valDQ 0.005 0.004 0.000 0.000 0.000 0.000
Q loss 90.92 104.71 119.80 129.98 126.75

• All other models are rejected by the UC test, with 8-13 violations; except the
ARCH-N and HS-100 models, with 6 and 7 violations respectively.

• The incorrect RM N model (13) has only 1 more violation than the simulation-
QBUS6830 (S2, 2022); Module 4; 42

based RM model (12). Both fail the UC test.

• The ARCH-t and iid N models are rejected by the Independence test for violations.

• However, the DQ test rejects ALL the models as having inaccurate 1% VaR
forecasts.

• The quantile loss function favours the EGARCH-N model, followed by GJR-
GARCH-N and EGARCH-t models.

• The HS-T, HS-100 and iid N models again do the worst by the quantile loss
function: these are the least accurate 1% VaR forecasters and most strongly
rejected by the DQ test too.

• The best models via the quantile loss function are ARCH-t, ARCH-N and EGARCH-
QBUS6830 (S2, 2022); Module 4; 43

t models.

• The models with the 3 highest loss values are the iid N, HS-100 and HS-T.

• For VaR 10-step forecasting at p = 0.01, all models are rejected by the DQ test,
except the GJR-N model, which is rejected by the UC test.

• Figure 13 shows 1% VaR violations for the ARCH-N, ARCH-t, HS-100 and RM
methods.

• Clearly the RM has too many violations.

• The ARCH-N and ARCH-t’s violations seem not to cluster at all. However,
their violations only occur in higher volatility periods, thus may be related to the
quantile forecasts, explaining why they failed the DQ test.
QBUS6830 (S2, 2022); Module 4; 44

CBA 10-day returns and 1% violations

ARCH-N
20 ARCH-t
HS-100
RM

10

10

20

30

2008 2010 2012 2014 2016 2018 2020 2022

Figure 13: 10 day returns for CBA plus 1% VaR10 violations for some models.

• For ES 10-step ahead forecasting at p = 0.01, we might expect ESRates close

to the range (Student-t) 0.0035-0.0038 (Gaussian), i.e. 1.26 − 1.37, or ≈ 1 ES
QBUS6830 (S2, 2022); Module 4; 45

Table 5: The 10-step-ahead forecast ES summary for all models for CBA, p = 0.01.

Model A G GJR EG RM A-t G-t

ES viols (1?) 4 9 4 5 11 4 7
Mean ξ -5.17 -2.67 -2.47 -2.24 -2.87 -5.46 -2.90
t-stat ξ -1.91 -2.01 -1.46 -1.45 -2.52 -1.74 -2.16
Mean ξs -1.41 -0.63 -0.60 -0.56 -0.70 -1.56 -0.68
t-stat ξs -1.78 -1.90 -1.25 -1.36 -2.37 -1.81 -1.90
p-val 0.14 0.08 0.24 0.20 0.04 0.14 0.08
Joint loss 4.49 4.63 4.33 4.40 4.55 4.41 4.64
RMSE ξ 7.96 5.31 5.64 5.39 4.76 8.30 5.32
MAD ξ 6.30 3.23 3.76 3.50 2.90 7.11 3.35
GJR-t EG-t RM N iid N HS-100 HS-T
ES viols (1?) 4 5 13 7 5 4
Mean ξ -1.80 -2.21 -3.89 -6.06 -3.77 -5.05
t-stat ξ -1.12 -1.51 -3.30 -2.52 -0.87 -1.54
Mean ξs -0.49 -0.57 -0.98 -1.69 -1.43 -1.49
t-stat ξs -1.00 -1.39 -3.56 -2.51 -1.14 -1.65
p-val 0.34 0.20 0.00 0.03 0.30 0.14
Joint loss 4.43 4.46 4.95 5.67 5.69 5.37
RMSE ξ 5.40 5.13 5.65 9.72 11.24 10.01
MAD ξ 3.55 3.25 3.89 6.62 9.71 8.00

violations on average..
QBUS6830 (S2, 2022); Module 4; 46

• The ARCH-N, ARCH-t, GJR-N, GJR-t and HS-T methods are all the closest to
that ES violation rate here, with 4 violations; unfortunately this rate is above the
1% expected for 1% VaR forecasts, which is problematic

• Most models seem inadequate by ES violation rate, all with above 4 (i.e. above
1%) ES violation rates.

• The RM and RM N methods are most inadequate here, with 11 and 13 ES

violations (both > 0.025 even!)

• The incorrect RM N model (13) has 2 more violations than the simulation-based
RM model (11). Both are way too large for 1% ES forecast VRates.

• The GJR-t model has ES residuals closest to mean 0 and t-stat closest to 0 with
highest p-value.
QBUS6830 (S2, 2022); Module 4; 47

• The t-tests on the standardised ES residuals find that the ES forecast residuals
are significantly different to a mean of 0 for the models: RM RM N and iid N i.e.
these ES forecast models are significantly biased for p = 0.01.

• The RM has smallest RMSE and MAD for the 1% ES residuals; but this is biased
by it having too many 1% ES residuals; since it has 12 1% VaR violations.

• The GJR-N model’s 1% VaR and ES forecasts have the lowest joint loss.

• The 3 models with clearly highest joint loss values, as well as clearly highest RMSE
and MAD values, are again the HS-100, iid N and HS-T methods.

• These 3 methods are clearly the least accurate 1% VaR and ES forecasters.

• At p = 0.01, the GJR-GARCH-N model appears to be the most accurate fore-

QBUS6830 (S2, 2022); Module 4; 48

caster of 10-day VaR and ES levels.

• Figures 14 and 15 show the forecasted ES10 residuals for some models for their
ES 1% forecasts.

• The models shown have between 5 and 8 VaR 1% violations, thus they also have
from 5-8 ES 1% residuals.

• The models shown seem to have close to mean 0 ES 1% residuals, but differing
variation levels, agreeing with the 1% ES table above.
QBUS6830 (S2, 2022); Module 4; 49

5.0

2.5

0.0

2.5

5.0

7.5

10.0
ARCH
ARCH-t
12.5 EG-t
RM
15.0 GARCH-t
GJR-GARCH
0 2 4 6 8 10

Figure 14: Forecast residuals for ES10 (p = 0.01): ξt , for ARCH, GJR-GARCH-N, ARCH-t, EGARCH-t, GARCH-t and RiskMetrics.

• The incorrect RM that assumed a Gaussian distribution for 10-day returns con-
sistently forecast VaR and ES marginally less accurately than the RM method,
QBUS6830 (S2, 2022); Module 4; 50

20

10

10

20
CBA 10-day returns and 2.5% violations
ARCH-N
GJR
30 HS-T
RM
2008 2010 2012 2014 2016 2018 2020 2022

Figure 15: Forecast residuals for ES10 (p = 0.01): ξt , for RM Gaussian, HS-100 and HS-T.

though usually both approaches were rejected.

QBUS6830 (S2, 2022); Module 4; 51

• For 10-day VaR and ES forecasting for p = 0.025, 0.01, the GJR-GARCH-N model
was consistently among the most accurate models and often the best and most
accurate model, for CBA.

• The 3 clearly worst methods for 10-day VaR and ES forecasting for p = 0.025, 0.01
were the HS-100, HS-T and iid N methods.

• Very, very long (daily) sample periods are needed to adequately compare and
assess VaR and ES forecasts for h = 10 and h > 1 in general.
Section (4e): Example, WES 10 day tail tisk forecasting
• Figure ?? shows the non-overlapping 10 day WES returns.

• The table below shows accuracy measures for p = 0.025 over the 375 10-day
periods for VaR forecasts.
QBUS6830 (S2, 2022); Module 4; 52

10

10

20

30
WES 10-day non-overlapping returns: 2000-2022
2000 2004 2008 2012 2016 2020

Figure 16: 10 day non-overlapping returns for WES, 2000-2022

• For p = 0.025 VaR 10 day ahead forecasting for WES, all models fail at least one
of the UC, ind or DQ tests.
QBUS6830 (S2, 2022); Module 4; 53

Table 6: The 10-step-ahead forecast VaR summary for all models for WES, p = 0.025.

Model A G GJR EG RM A-t G-t

Viols (9-10) 17 20 19 20 17 16 20
VRate (0.025) 0.045 0.053 0.051 0.053 0.045 0.043 0.053
Ratio 1.81 2.13 2.03 2.13 1.81 1.71 2.13
p-valU C 0.012 0.000 0.001 0.000 0.012 0.028 0.000
p-valind 0.795 0.942 0.969 0.390 0.795 0.708 0.942
p-valDQ 0.043 0.006 0.015 0.013 0.048 0.055 0.007
Q loss 160.40 160.27 158.81 161.70 159.06 161.51 161.32
GJR-t EG-t RM N iid N HS-100 HS-T
Viols (3-4) 19 18 19 17 14 13
VRate (0.01) 0.051 0.048 0.051 0.045 0.037 0.035
Ratio 2.027 1.920 2.027 1.813 1.493 1.387
p-valU C 0.001 0.004 0.001 0.012 0.126 0.231
p-valind 0.969 0.882 0.969 0.214 0.097 0.071
p-valDQ 0.017 0.072 0.014 0.004 0.043 0.006
Q loss 161.64 161.62 160.50 186.35 188.20 196.28

• All models have higher VRates than 2.5%; the closest in VRate to 2.5% are the
HS-T and HS-100 and these are the only 2 models not rejected by the UC test

• Though both HS-T and HS-100 fail the DQ test and also have the highest/worst
QBUS6830 (S2, 2022); Module 4; 54

quantile loss values, i.e. they are the furthest from the true 2.5% VaR series.

• The models with the best and lowest quantile loss are the GJR-N and RM, though
both are rejected by the UC and DQ tests.

• For models rejected by only 1 test, those with lowest quantile loss are: ARCH-t,
EGARCH-t.

• Figure 17 shows 2.5% VaR violations for the ARCH-t, GJR-N, HS-T and RM-N
methods.

• Clearly the RM-N has too many violations.

• The GJR-N’s violations may cluster in 2008 and especially 2020, explaining why
the GJR-N failed the DQ test. The ARCH-t shares only 3 of the 4 GJR-N
QBUS6830 (S2, 2022); Module 4; 55

violations in 2008 and 1 or the 2 close together GJR-N violations in 2022; this
explains why it doesn’t fail the DQ test.

• Overall, the best model for forecasting 2.5% 10 day WES VaR is the ARCH-t.
Though it has too many violations, at least these occur approximately indepen-
dently.

• The table below shows accuracy measures for p = 0.01 over the 375 10-day periods
for VaR forecasts.

• For p = 0.01 VaR 10 day ahead forecasting for WES, all models fail at least one
of the UC, ind or DQ tests.

• All models have higher VRates than 1%; the closest in VRate to 1% is the HS-T
this is the only model not rejected by the UC test.
QBUS6830 (S2, 2022); Module 4; 56

10

10

20

WES 10-day returns and 2.5% violations

ARCH-t
30 GJR
HS-T
RM N
2008 2010 2012 2014 2016 2018 2020 2022

Figure 17: 10 day returns for WES plus 2.5% VaR10 violations for some models.

• The HS-T fails the DQ test and also has the 2nd highest/worst quantile loss value,
i.e. it is the 2nd furthest from the true 1% VaR series.
QBUS6830 (S2, 2022); Module 4; 57

Table 7: The 10-step-ahead forecast VaR summary for all models for WES, p = 0.01.

Model A G GJR EG RM A-t G-t

Viols (3-4) 10 14 14 14 16 10 14
VRate (0.01) 0.027 0.037 0.037 0.037 0.043 0.027 0.037
Ratio 2.67 3.73 3.73 3.73 4.27 2.67 3.73
p-valU C 0.001 0.000 0.000 0.000 0.000 0.001 0.000
p-valind 0.256 0.540 0.540 0.540 0.708 0.256 0.540
p-valDQ 0.003 0.000 0.000 0.000 0.000 0.002 0.000
Q loss 82.97 93.87 91.26 89.20 91.73 82.55 91.32
GJR-t EG-t RM N iid N HS-100 HS-T
Viols (3-4) 14 14 16 10 8 6
VRate (0.01) 0.037 0.037 0.043 0.027 0.021 0.016
Ratio 3.73 3.73 4.27 2.67 2.13 1.60
p-valU C 0.000 0.000 0.000 0.001 0.027 0.243
p-valind 0.540 0.540 0.708 0.022 0.152 0.075
p-valDQ 0.000 0.000 0.000 0.000 0.004 0.000
Q loss 91.55 89.73 95.67 120.28 110.48 114.56

• The models with the best and lowest quantile loss are the ARCH-t and ARCH-N,
though both are strongly rejected by both the UC and DQ tests.

• Only the HS-T model is rejected by only 1 test, but it is the 2nd worst for quantile
QBUS6830 (S2, 2022); Module 4; 58

loss.

• Figure 18 shows 1% VaR violations for the ARCH-t, GJR-N, HS-T and RM-N
methods.

• Clearly the RM-N has too many violations.

• The GJR-N’s and ARCH-t’s violations may cluster in early 2020, with 2 violations
in 2 days, explaining why these models failed the DQ test.

• Overall, there is no best model for forecasting 1% 10 day WES VaR.

QBUS6830 (S2, 2022); Module 4; 59

10

10

20

WES 10-day returns and 1% violations

ARCH-t
30 GJR
HS-T
RM N
2008 2010 2012 2014 2016 2018 2020 2022

Figure 18: 10 day returns for WES plus 1% VaR10 violations for some models.