Estimation Output. The vector autoregression VAR is commonly used for forecasting systems of interrelated time series and for analyzing the dynamic impact of random disturbances on the system of variables.

### How can we estimate the structural VAR in eviews

The reduced form VAR approach sidesteps the need for structural modeling by treating every endogenous variable in the system as a function of p -lagged values of all of the endogenous variables in the system. Below, we offer an abbreviated description of important features of the model.

We may write the stationary, -dimensional, VAR p process as. The last statement implies that the vector of innovations are contemporaneously correlated with full rank matrixbut are uncorrelated with their leads and lags of the innovations and assuming the usual orthogonality uncorrelated with all of the right-hand side variables.

Let the vector. Then for observationswe may write this model in compact system form as:.

Geometry problemsFurthermore, even though the innovations may be contemporaneously correlated, all of the equations in the system have identical regressors so that OLS is both equivalent to GLS and efficient. Later, when we describe estimation of restricted VAR models, we relax the identical regressors assumption so that OLS is no longer efficient.

Applying least squares estimation to the stacked representation yields the least squares estimator. To obtain an estimator of the covariance matrix we require an estimate ofwhich is typically obtained using the d. As an example, suppose that industrial production IP and money supply M1 are jointly determined by a VAR 2 and let a constant be the only exogenous variable.

Then the VAR may be written as:. We begin with a simple reduced form VAR. You should fill out the dialog with the appropriate information:.

You may list the series individually or you may include one or more series in a group object and enter the group name. This information is entered in pairs where each pair of numbers defines a range of lags. For example, the lag pair shown above:. Through use of multiple lag pairs you may place zero restrictions on particular lag coefficient matricesas desired. Simply add any number of lag intervals, all entered in pairs, omitting those lags you wish to restrict.

For example, he lag specification:.

## Backtesting Value-at-Risk (VaR): The Basics

Note that restrictions entered in this fashion restrict the entire matrix to be zero.This metric is most commonly used by investment and commercial banks to determine the extent and occurrence ratio of potential losses in their institutional portfolios. Investment banks commonly apply VaR modeling to firm-wide risk due to the potential for independent trading desks to unintentionally expose the firm to highly correlated assets.

Using a firm-wide VaR assessment allows for the determination of the cumulative risks from aggregated positions held by different trading desks and departments within the institution.

**Module 5: Session 7: Vector AutoRegreSsion (VAR) Diagnostics: RESIDUALS in EVIEWS**

There is no standard protocol for the statistics used to determine asset, portfolio or firm-wide risk. Risk may be further understated using normal distribution probabilities, which rarely account for extreme or black-swan events.

The assessment of potential loss represents the lowest amount of risk in a range of outcomes. Risk magnitude was also underestimated, which resulted in extreme leverage ratios within subprime portfolios.

As a result, the underestimations of occurrence and risk magnitude left institutions unable to cover billions of dollars in losses as subprime mortgage values collapsed. Business Essentials. Portfolio Management.

Risk Management. Tools for Fundamental Analysis. Your Money. Personal Finance. Your Practice. Popular Courses. Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Terms How Risk Analysis Works Risk analysis is the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector.

Risk Risk takes on many forms but is broadly categorized as the chance an outcome or investment's actual return will differ from the expected outcome or return. Market Risk Definition Market risk is the possibility of an investor experiencing losses due to factors that affect the overall performance of the financial markets. Risk Management in Finance In the financial world, risk management is the process of identification, analysis and acceptance or mitigation of uncertainty in investment decisions.

Risk management occurs anytime an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment. Incremental Value At Risk Incremental value at risk is the amount of uncertainty added or subtracted from a portfolio by purchasing a new investment or selling an existing one. Partner Links. Related Articles.Value-at-risk VaR is a widely used measure of downside investment risk for a single investment or a portfolio of investments. VaR gives the maximum-dollar loss on a portfolio over a specific time period for a certain level of confidence.

Each methodology relies on creating a distribution of investment returns; put another way, all possible investment returns are assigned a probability of occurrence over a specified time period. The challenge lies in assessing the accuracy of the measure and, thus, the accuracy of the distribution of returns.

Knowing the accuracy of the measure is particularly important for financial institutions because they use VaR to estimate how much cash they need to reserve to cover potential losses.

Any inaccuracies in the VaR model may mean that the institution is not holding sufficient reserves and could lead to significant losses, not only for the institution but potentially for its depositors, individual investors and corporate clients. In extreme market conditions such as those that VaR attempts to capture, the losses may be large enough to cause bankruptcy. Risk managers use a technique known as backtesting to determine the accuracy of a VaR model.

A backtest relies on the level of confidence that is assumed in the calculation.

Gamo wildcat whisper manualFor a one-day VaR measure, risk managers typically use a minimum period of one year for backtesting. The simple backtest has a major drawback: it's dependent on the sample of actual returns used.

If the investor uses a different day period, there may be fewer or a greater number of exceptions. This sample dependence makes it difficult to ascertain the accuracy of the model. To address this weakness, statistical tests can be implemented to shed greater light on whether a backtest has failed or passed. When a backtest fails, there are a number of possible causes that need to be taken into consideration:. If the VaR methodology assumes a return distribution e. Statistical goodness-of-fit tests can be used to check that the model distribution fits the actual observed data.

Alternatively, a VaR methodology that does not require a distribution assumption can be used. If the VaR model captures, say, only equity market risk while the investment portfolio is exposed to other risks such as interest rate risk or foreign exchange risk, the model is misspecified.

In addition, if the VaR model fails to capture the correlations between the risks, it is considered to be misspecified.

Kaytranada bandcampThis can be rectified by including all the applicable risks and associated correlations in the model. It is important to reevaluate the VaR model whenever new risks are added to a portfolio. The actual portfolio losses must be representative of risks that can be modeled. More specifically, the actual losses must exclude any fees or other such costs or income. Although VaR offers useful information about worst-case risk exposure, it is heavily reliant on the return distribution employed, particularly the tail of the distribution.

Since tail events are so infrequent, some practitioners argue that any attempts to measure tail probabilities based on historical observation are inherently flawed.

According to Reuters"VaR came in for heated criticism following the financial crisis as many models failed to predict the extent of the losses that devastated many large banks in and The reason? In an attempt to address these inadequacies, risk managers supplement the VaR measure with other risk measures and other techniques such as stress testing.

Value-at-Risk VaR is a measure of worst-case losses over a specified time period with a certain level of confidence. The measurement of VaR hinges on the distribution of investment returns.

## Incremental VaR & other VaR metrics

In order to test whether or not the model accurately represents reality, backtesting can be carried out. A failed backtest means that the VaR model must be reevaluated. Tools for Fundamental Analysis. Financial Analysis. Portfolio Management. Risk Management. Your Money.All Rights Reserved.

Statistical methods are used to evaluate the forecasting performance of all the models. The skewed-t distribution seems to provide relatively superior results than the other two densities. Backtests results are quite satisfactory. Article Outline 1. Introduction 2. Identifying the Conditional Mean Equation 3. Forecasting 4.

Comparative Analysis 5. Introduction Extreme market risk is an important type of financial risk, which is generally caused by extreme price movements in the financial market. Although this risk occurs in small probabilities, it can cause disastrous consequences on the market by engendering substantial financial losses. This random risk has prompted researchers, regulators and policymakers to develop diverse methodologies to understand the likelihood and extent of extreme rare events which help explain stock market crashes or currency crises, losses on financial assets, catastrophic insurance claims, credit losses or even losses incurred due to natural disasters.

Value-at-Risk VaR is a popular tail-related risk measure which provides a reasonable and realistic quantification of extreme market risk. It is extensively used by investors, banks, traders, financial managers and regulators to monitor the level of risk. According to to Jorion [1], Value-at-Risk VaR is the worst loss that will not be exceeded with a certain level of confidence, during a particular period of time.

It is often associated with extreme downside losses caused by extreme deviations in market conditions. So much so, that the necessity to accurately estimate VaR has led to the development of diverse methodologies for extreme risk management. GARCH are robust techniques developed for the modelling of high frequency time series data.

Past experiments show that they efficiently capture the stylised feature of volatility clustering in financial data. According to [5] and [6], the GARCH 1,1 specification is the most widely used and has proved to be a successful volatility technique in many past studies. Nevertheless, other mathematical explanations have been proposed to enlighten the issue of fat tails in modeling extreme market risk. Similarly, other several studies have attempted to challenge the general Gaussian assumption and provide better techniques to model tail-risk measure VaR, such as the Extreme Value Theory EVT.

Extreme Value Theory EVT is a robust tool for studying the tail of a distribution as it provides a plausible theoretical foundation whereby statistical models, which describe extreme and rare events, can be constructed. Balkema and de-Haan as well as Pickands further explored the theory and presented important results for threshold-based extreme value techniques.

Since then, EVT has proved to be useful in many spheres of life, including Finance. EVT is basically a parametric model which captures the extreme tails of a distribution in order to forecast risk. It allows the estimation of extreme quantiles, making it an attractive model for Value-at-Risk VaR estimation, as it provides better distributions to fit those extreme data.

Hessian matrix exampleThe POT is often preferred over BMM as the former approach makes efficient use of the available data by picking all relevant observations beyond a particular high threshold while the latter approach considers only the extreme values in specified blocks.

InPickands devised the theoretical framework and statistical tools for the POT method whereby only those observations which exceed a particular sufficiently high threshold are considered. Under extreme value conditions, the absolute exceedances over the threshold value u are said to follow the Generalised Pareto Distribution GPD as per the Pickands, Balkema-in Haan Theorem. They found that distribution of extremes, clustering, asymmetry, as well as the dynamic structure of VaR are important criteria to be considered during comparison of the various methods.

Several other researchers have attempted to analyse extreme fluctuations in financial markets. Most of them have provided details on the tail behaviour of financial data and examined the prospect of EVT as a risk management tool [8, ], and many of the them revealing that traditional VaR models provided poorer estimates than EVT-based models at higher levels of confidence. The combination of EVT with stochastic models allowed quantile estimation of risk for financial return series, which was then used to obtain VaR estimates.

Backtests of this method showed that this two-step procedure technique outperformed not only the traditional GARCH models with both normal and t distributions, but also the unconditional EVT approach. Their proposed method worked quite well for return series with symmetric tails, but failed when the tails were asymmetric.

They consequently advocated the use of GPD approximation in the second step. Experiments which followed actually showed that this two-step procedure gave adequate estimates as compared to methods which ignored the tail distribution.Have you ever wondered what Value at Risk VaR numbers would look like across the same dataset but using the different calculation approaches? We will then dig deeper and calculate incremental VaR, marginal VaR and conditional value at risk.

And before we close we will take a short stab at the probability of shortfall. You may like to refresh your memory regarding the description and basic mechanics of each approach by taking some time first to look at the following posts before proceeding ahead:. In addition to going through these approaches, we will also look at other VaR related risk measures such as:. Before we move on to the specifics of each approach we will determine the return time series for each position.

Obtain this is by taking the natural logarithm of successive prices. This return series is the foundation for all the methods except Monte Carlo simulation and metrics mentioned above:. We will also determine the portfolio return series. As you may recall, this return series is a correlation adjusted series.

A series that takes into account the correlation between the various positions in the portfolio. Using the weights of each position with respect to the portfolio we calculated a weighted average sum of the returns for each point in time:.

This method assumes that the daily returns follow a normal distribution. The daily Value at Risk is simply a function of the standard deviation of the positions return series and the desired confidence level. Once we have obtained daily volatility we determine the daily VaR. This is the product of the volatility and the inverse of the standard normal cumulative distribution for a specific confidence level. Historical simulation is a non-parametric approach for estimating VaR. The returns are not subjected to any functional distribution.

Estimate VaR directly from the data without deriving parameters or making assumptions about the entire distribution of the data. This methodology is based on the premise that the pattern of historical returns is indicative of future returns.

We use the histogram of returns to determine daily VaR. Alternatively, you may derive the histogram yourself as follows:.

Nouveau vs nvidiaThe approach is similar to the Historical simulation method described above except for one big difference. A hypothetical data set is generated by a statistical distribution rather than historical price levels. The assumption is that the selected distribution captures or reasonably approximates the price behavior of the modeled securities.We use cookies to offer you a better experience, personalize content, tailor advertising, provide social media features, and better understand the use of our services.

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By continuing to use this site, you consent to the use of cookies. We value your privacy. Asked 1st Jan, Ihtsham Ul Haq Padda. How can we estimate the structural VAR in eviews. I want to estimate in eviews however, any other package can also be referred. Applied Econometrics. Time Series Analysis.

Econometric Applications. Most recent answer. Amira Akl Ahmed. Benha University. Popular Answers 1.

Mansor H. International Centre for Education in Islamic Finance. Really sorry. All Answers Deleted profile. If not, then there is always the choice to estimate your VAR manually as a system of truncated auto-regressive equations using the same estimation method as with VAR MLE. Dear Pandelis Mitsis.

Thanks a lot. It is hepful. If you give me email, I can send you powerpoints and instructions for estimating the AB model together with some sample articles. Dear Mansoor Ibrahim. Thanks for interesting explaination. Please send me the powerpoint presentation and articles on ihtsham91 yahoo.Apart from professional assessment tools, we can calculate the value at risk by formulas in Excel easily.

In this article, I will take an example to calculate the value at risk in Excel, and then save the workbook as an Excel template. Create a Value at Risk table and only save this table selection as a mini template.

Kutools for Excel Exact Copy utility can help you easily copy multiple formulas exactly without changing cell references in Excel, preventing relative cell references updating automatically. Full Feature Free Trial day! Now please follow the tutorial to calculate how much your will lose potentially. Step 1: Create a blank workbook, and enter row headers from A1:A13 as the following screen shot shown. And then enter your original data into this simple table.

So far we have figured out the values at risk of every day and every month. To make the table friendly readable, we go ahead to format the table with following steps. Normally Microsoft Excel saves the whole workbook as a personal template. But, sometimes you may just need to reuse a certain selection frequently.

Comparing to save the entire workbook as template, Kutools for Excel provides a cute workaround of AutoText utility to save the selected range as an AutoText entry, which can remain the cell formats and formulas in the range.

And then you can reuse this range with just one click. How to make a read-only template in Excel? How to find and change default save location of Excel templates? Log in. Remember Me Forgot your password?

Forgot your username? Password Reset. Please enter the email address for your account. A verification code will be sent to you. Once you have received the verification code, you will be able to choose a new password for your account. Please enter the email address associated with your User account. Your username will be emailed to the email address on file.

How to create Value at Risk template in Excel? Create a Value at Risk table and save as template Create a Value at Risk table and only save this table selection as a mini template. Read More Free Download Step 2: Now calculate the value at risk step by step:.

Save range as mini template AutoText entry, remaining cell formats and formulas for reusing in future. You are guest Login Now. Loading comment The comment will be refreshed after To post as a guest, your comment is unpublished. Hi, thank you for the tutorial. It's very useful.

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