Abstract
The need for understanding financial risk management and unique models for measuring risk in transitional capital markets increasingly gains in importance and becomes a very current issue. This article studies predictive ability of various classes of Value-at-Risk (VaR) models focusing on Serbian equity market in both stressed and normal market conditions. The five VaR models adopted in our evaluation procedure include: historical simulation with rolling window of 500 days, Risk Metrics, exponentially-weighted moving average (EWMA) with optimized decay factor, VaR based on models from GARCH family under three distributional assumptions (normal, generalized error, and Student-t), and Filtered historical simulation. In order to verify the forecasting performance of different VaR models, we employ a backtesting procedure, which consists of statistical tests. The results indicate that VaR based on conditional volatility models with asymmetric distribution of innovations behave reasonably well in both tranquil and crisis period. Standard VaR models developed for liquid and efficient markets seriously underestimate risk forecast in Serbian equity market under all circumstances.
Highlights
As KPMG (2008) pointed out: “The growing magnitude and complexity of trading accounts, coupled with increased market volatility over the last decade, have pushed financial institutions and regulators to adopt large-scale risk measurement models
There are frontier equity markets, which have inherent valuation risk that could be material, which would not be picked up at the 95/99 percent VaR levels, highlighting the need to establish whether VaR is appropriate for particular asset classes in those markets (KPMG, 2008)
Conducted preliminary statistical tests indicated that volatility clustering and occurrence of extreme negative returns characterize the returns of stock index
Summary
As KPMG (2008) pointed out: “The growing magnitude and complexity of trading accounts, coupled with increased market volatility over the last decade, have pushed financial institutions and regulators to adopt large-scale risk measurement models. The VaR model assumes that positions can be liquidated over a specified period This liquidity assumption has proved invalid over the course of recent market events in both developed and emerging equity markets. The fact that the recent financial market crisis, originated in the American sub-prime mortgage market, had important implications on sudden drop in developed equity markets liquidity; the situation is more complex when we consider frontier stock markets, where stocks become practically illiquid. For VaR outputs to be reliable, we should have rigorous model validation and calibration processes Those processes are a critical feature of financial risk management to ensure that VaR models are producing reliable and consistent VaR figures, on which we can make competent decisions. There are frontier equity markets, which have inherent valuation risk that could be material, which would not be picked up at the 95/99 percent VaR levels, highlighting the need to establish whether VaR is appropriate for particular asset classes in those markets (KPMG, 2008)
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