Evaluation of correlation forecasting models for risk management

Reliable correlation forecasts are of paramount importance in modern risk management systems. A plethora of correlation forecasting models have been proposed in the open literature, yet their impact on the accuracy of value‐at‐risk calculations has not been explicitly investigated. In this paper, tr...

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Bibliographic Details
Published in:Journal of forecasting 2007-11, Vol.26 (7), p.497-526
Main Authors: Skintzi, Vasiliki D., Xanthopoulos-Sisinis, Spyros
Format: Article
Language:English
Subjects:
Bond portfolios
Correlation
Correlation analysis
Financial engineering
forecasting
Forecasting techniques
GARCH
GARCH models
Portfolio management
Risk management
Stochastic models
Studies
value-at-risk
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Summary:Reliable correlation forecasts are of paramount importance in modern risk management systems. A plethora of correlation forecasting models have been proposed in the open literature, yet their impact on the accuracy of value‐at‐risk calculations has not been explicitly investigated. In this paper, traditional and modern correlation forecasting techniques are compared using standard statistical and risk management loss functions. Three portfolios consisting of stocks, bonds and currencies are considered. We find that GARCH models can better account for the correlation's dynamic structure in the stock and bond portfolios. On the other hand, simpler specifications such as the historical mean model or simple moving average models are better suited for the currency portfolio.  Copyright © 2007 John Wiley & Sons, Ltd.
ISSN:0277-6693
1099-131X
DOI:10.1002/for.1036