Implementing VaR in ABC Bank You were hired by ABC Bank as an equity portfolio manager. Your supervisor possesses good skills in in bond investments but not in equity. However, he believes that there is a huge opportunity in recent as the Hang Seng Index (HSI) experienced a 20 percent plunge, which dropped from the peak of $33,154 (on January 26th 2018) to a recent low of $25,707 (on October 10th 2019). You were assigned to a trading team of four and you are the team leader. The bank allocated $9m to your team as the investment capital, and you are required to create two equity portfolios. The first portfolio is a $6m speculative portfolio that aimed to capture any short-term opportunity, and the second portfolio is a $3m income portfolio for long-term investment purpose. Contrary to your supervisor, you are pessimistic about the economy as the trade war escalates and protests compound growth concerns in Hong Kong. You considered to adopt the quantitative risk control measure Value-at-Risk (VaR) to monitor the downside risk. However, after lengthy discussion, your supervisor still not being convinced that VaR is effective in risk management. He required you to conduct both backtesting and forward testing, and compile a report to him for evaluating the effectiveness of the 1-day 99% VaR. Details: 1. Both the speculative and income portfolios should be an equally weighted 3-stock portfolio. You have to explain your stock choices in details. 2. Obtain the 5-year historical price data and calculate the daily returns. The first year data (250 trading days) is for model setting. (Refer to point 4(a)) 3. Plot the daily return histograms and include them in the report. Based on the histogram shapes, comment any issue that related to VaR. 4. Calculate the 1-day 99% VaR in both individual stock and portfolio level by the following method: a. Riskmetrics method. 1. Sigma is calculated based on the 250 actual returns (So, if your data starts on 1 Oct 2015, the first VaR to report should be on 1 Oct 2016 or 250 trading days later) Calculate the portfolio VaR by: 1. obtaining the portfolio actual sigma 2. obtaining the 1-day VaR of individual stock then apply the correlation formula. III. Comment your findings b. CAPM. 1. Estimate the stock beta to obtain the stock's sigma II. 1. Stock beta can be obtain by the formula of Bi = cov(ri, rm)/ om), where r is stock i return and Im is the return of market portfolio II. Calculate the portfolio VaR by using the correlation formula C. Historical Simulation method. 5. Backtesting the effectiveness of VaR for all the methods in point 4. a. Obtain the actual return of your asset, compare it against the VaR. Mark it as a "violation" if your return is less than the value of VaR. b. You may summarize your results in the following format Year Number of violations 2018 3 2017 2016 5 2015 6 C. Give comments on your results 4 6. Forward testing the effectiveness of VaR for all the methods in point 4. a. Forward testing is an out-of-sample test. For example, if you obtained the VaR value is -2.83% on 1 Oct 2015, you should check how many Var violations of the asset's return in the period of 2 Oct 2015 to 1 Oct 2016 (actually should be 250 trading days onwards). b. You may summarize your results by plotting the number of violation line graphs. C. Give comments on your results. d. Hints: you can use the excel function "countif". 7. Further from the backtesting and forward testing you performed in your report, suggest another test for testing VaR effectiveness. (Do your own research on this) 8. Provide a conclusion in the report. *Note: You can simply remove all the null value in your data series Implementing VaR in ABC Bank You were hired by ABC Bank as an equity portfolio manager. Your supervisor possesses good skills in in bond investments but not in equity. However, he believes that there is a huge opportunity in recent as the Hang Seng Index (HSI) experienced a 20 percent plunge, which dropped from the peak of $33,154 (on January 26th 2018) to a recent low of $25,707 (on October 10th 2019). You were assigned to a trading team of four and you are the team leader. The bank allocated $9m to your team as the investment capital, and you are required to create two equity portfolios. The first portfolio is a $6m speculative portfolio that aimed to capture any short-term opportunity, and the second portfolio is a $3m income portfolio for long-term investment purpose. Contrary to your supervisor, you are pessimistic about the economy as the trade war escalates and protests compound growth concerns in Hong Kong. You considered to adopt the quantitative risk control measure Value-at-Risk (VaR) to monitor the downside risk. However, after lengthy discussion, your supervisor still not being convinced that VaR is effective in risk management. He required you to conduct both backtesting and forward testing, and compile a report to him for evaluating the effectiveness of the 1-day 99% VaR. Details: 1. Both the speculative and income portfolios should be an equally weighted 3-stock portfolio. You have to explain your stock choices in details. 2. Obtain the 5-year historical price data and calculate the daily returns. The first year data (250 trading days) is for model setting. (Refer to point 4(a)) 3. Plot the daily return histograms and include them in the report. Based on the histogram shapes, comment any issue that related to VaR. 4. Calculate the 1-day 99% VaR in both individual stock and portfolio level by the following method: a. Riskmetrics method. 1. Sigma is calculated based on the 250 actual returns (So, if your data starts on 1 Oct 2015, the first VaR to report should be on 1 Oct 2016 or 250 trading days later) Calculate the portfolio VaR by: 1. obtaining the portfolio actual sigma 2. obtaining the 1-day VaR of individual stock then apply the correlation formula. III. Comment your findings b. CAPM. 1. Estimate the stock beta to obtain the stock's sigma II. 1. Stock beta can be obtain by the formula of Bi = cov(ri, rm)/ om), where r is stock i return and Im is the return of market portfolio II. Calculate the portfolio VaR by using the correlation formula C. Historical Simulation method. 5. Backtesting the effectiveness of VaR for all the methods in point 4. a. Obtain the actual return of your asset, compare it against the VaR. Mark it as a "violation" if your return is less than the value of VaR. b. You may summarize your results in the following format Year Number of violations 2018 3 2017 2016 5 2015 6 C. Give comments on your results 4 6. Forward testing the effectiveness of VaR for all the methods in point 4. a. Forward testing is an out-of-sample test. For example, if you obtained the VaR value is -2.83% on 1 Oct 2015, you should check how many Var violations of the asset's return in the period of 2 Oct 2015 to 1 Oct 2016 (actually should be 250 trading days onwards). b. You may summarize your results by plotting the number of violation line graphs. C. Give comments on your results. d. Hints: you can use the excel function "countif". 7. Further from the backtesting and forward testing you performed in your report, suggest another test for testing VaR effectiveness. (Do your own research on this) 8. Provide a conclusion in the report. *Note: You can simply remove all the null value in your data series
