Overview

The task you are given is to estimate the market risk for a holding of 10,000 Macquarie Bank shares (MQG.ax) and 5,000 Westpac shares (WBC.ax), held on August 1 , 2018 (you are working out the risk position assuming that you own these shares before the open of trading that day).You will do this by estimating the Value-at-Risk for the stock portfolio.This will require you to choose the best VaR model by backtesting several methods to determine the most reliable for the task at hand.

Description

You will be asked to calculate the following;

-10 day VaR for the portfolio of shares at a confidence level of 99%.

Note: This risk estimate applies to the next 10 trading days from August 1, 2018 until August 14, 2018 (i.e. - it should be a forecast of risk).

Based on what you have learnt from EFB344, you are considering several options for how to compute this risk measure, a) the normal distribution using the EWMA, or b) historical simulation based on a rolling window.Both methods require choosing parameters to assign weight to past data, for the EWMA and the window length for the historical simulation.You will consider several possibilities for each as per the following;

EWMA - 1

for both volatilities and the covariance.

EWMA - 2

for both volatilities and the covariance.

EWMA - 3

for the volatilities and for the covariance.

Historical Simulation - 1

Rolling window with 252 trading days.

Historical Simulation - 2

Rolling window with 500 trading days.

This leaves you with 5 possible models that could be used to provide the VaR measure asked for above.You must choose the most appropriate model and report the associated VaR.To inform your decision of which to use, you are going to consider the recent historical performance of the five models in calculating 1 day VaR at the confidence level of 99%.You will do so by first examining the frequency of instances when the VaR was exceeded by the observed return over the prior five years.

You will then evaluate the appropriateness of these frequencies over time relative to the Basel traffic light levels discussed in lectures (over the same five years).Based on this performance, select the best model and report the required VaR(10, 99%) for August 1, 2018.