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Statistics & Risk Modeling

with Applications in Finance and Insurance

Editor-in-Chief: Stelzer, Robert

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Cite Score 2017: 0.96

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Source Normalized Impact per Paper (SNIP) 2017: 0.853

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Volume 33, Issue 3-4

Issues

Verification of internal risk measure estimates

Mark H. A. Davis
  • Department of Mathematics, Imperial College London, South Kensington Campus, London SW7 2AZ, United Kingdom of Great Britain and Northern Ireland
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Published Online: 2016-01-14 | DOI: https://doi.org/10.1515/strm-2015-0007

Abstract

This paper concerns sequential computation of risk measures for financial data and asks how, given a risk measurement procedure, we can tell whether the answers it produces are ‘correct’. We draw the distinction between ‘external’ and ‘internal’ risk measures and concentrate on the latter, where we observe data in real time, make predictions and observe outcomes. It is argued that evaluation of such procedures is best addressed from the point of view of probability forecasting or Dawid’s theory of ‘prequential statistics’ [12]. We introduce a concept of ‘calibration’ of a risk measure in a dynamic setting, following the precepts of Dawid’s weak and strong prequential principles, and examine its application to quantile forecasting (VaR – value at risk) and to mean estimation (applicable to CVaR – expected shortfall). The relationship between these ideas and ‘elicitability’ [24] is examined. We show in particular that VaR has special properties not shared by any other risk measure. Turning to CVaR we argue that its main deficiency is the unquantifiable tail dependence of estimators. In a final section we show that a simple data-driven feedback algorithm can produce VaR estimates on financial data that easily pass both the consistency test and a further newly-introduced statistical test for independence of a binary sequence.

Keywords: Risk measures; probability forecasting; prequential statistics; quantile and mean forecasting; calibration of estimates

MSC 2010: 62A01; 91B30; 91G70

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About the article

Received: 2015-03-15

Revised: 2015-09-17

Accepted: 2015-11-18

Published Online: 2016-01-14

Published in Print: 2016-12-01


Citation Information: Statistics & Risk Modeling, Volume 33, Issue 3-4, Pages 67–93, ISSN (Online) 2196-7040, ISSN (Print) 2193-1402, DOI: https://doi.org/10.1515/strm-2015-0007.

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