Volatility forecasting, value- at- risk and expected shortfall estimations under the Basel II Accord in GCC shariah stocks

Abstract

The main purpose of this chapter is to assess risk for shariah-compliant stocks in the Gulf Cooperation Council (GCC) countries using the value-at-risk (VaR) and expected shortfall (ES) under Basel II Accord rules. Empirically, we conduct our forecasting analysis using the asymmetric power ARCH (APARCH) model under three return innovations’ distributions: normal, Student and skewed Student. Using daily data for Saudi Arabia, Kuwait, Oman and United Arab Emirates (July 2010–13), our results indicate that the APARCH model under skewed Student distribution out-performs the competing models and it sufficiently accounts for asymmetry and heavy tails in the shariah returns. Furthermore, this model provides more accurate VaRs and ES for both short and long positions. Finally, the APARCH model provides the lowest number of violations under the Basel II rules, given a risk exposure at the 99 per cent confidence level for all four shariah indexes. Our findings are useful for shariah market risks, Islamic hedge funds, policy regulations and for designing hedging strategies for shariah portfolios.