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Keywords:

  • asymmetric Laplace distribution;
  • exponential smoothing;
  • forecasting;
  • skewness and heavy tails;
  • time-varying parameters;
  • value-at-risk (VaR)

ABSTRACT

Value-at-risk (VaR) is a standard measure of market risk in financial markets. This paper proposes a novel, adaptive and efficient method to forecast both volatility and VaR. Extending existing exponential smoothing as well as GARCH formulations, the method is motivated from an asymmetric Laplace distribution, where skewness and heavy tails in return distributions, and their potentially time-varying nature, are taken into account. The proposed volatility equation also involves novel time-varying dynamics. Back-testing results illustrate that the proposed method offers a viable, and more accurate, though conservative, improvement in forecasting VaR compared to a range of popular alternatives. Copyright © 2013 John Wiley & Sons, Ltd.