International Research Journal of Finance and Economics ISSN 1450-2887 Issue 22 (2008) EuroJournals Publishing, Inc. 2008 http://www.eurojournals.com/finance.

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Value-at-Risk for Long and Short Positions of Asian Stock Markets

Anthony H. Tu Department of Finance, National Chengchi Universit Woon K. Wong Cardiff Business School, Cardiff University, Aberconway Building Colum Drive, Cardiff CF10 3EU, U.K Matthew C. Chang Department of Finance and Banking, Hsuan Chuang University, No. 48 Hsuan Chuang Rd., Hsinchu City, 300, Taiwan E-mail: a04979@gmail.com Tel: +886-3-530-2255, Ext. 6024; Fax: +886-3-539-1292 Abstract Empirical research shows that stock market returns distributions can be asymmetric and the auto-correlations of its absolute returns are stronger than that of its squared returns. An asymmetric returns distribution means that the left and right tails would have different thickness, whereas higher auto-correlation of absolute returns implies that better volatility forecasts are possible. This has significant economic implication for risk management that requires accurate estimation of Value-at-Risk (VaR). In this paper, we therefore investigate the performance of VaR models that take into consideration of the skewness of the innovation process and utilize the Box-Cox transformation of conditional variance in a flexible ARCH-type model. Specificaly, we use the Asymmetric Power Autoregressive Conditional Heteroscedasticity (APARCH) model based on the skewed Student density to model the VaRs of daily returns of those Asian markets found to exhibit both skewness and kurtosis in the innovation process. We apply the likelihood ratio tests of proportional failure rates to such VaR model and compare the results with other VaR models, in particular, APARCH with symmetric distributions and APARCH with skewed Student distributions. It is found that the APARCH model with skewed Student distribution performs the best for the Asian markets considered. Keywords: Value-at-Risk, APARCH, GJR, RiskMetrics, Skewed Student distribution, Box-Cox transformation, proportional failure rates, likelihood ratio tests JEL Classification Codes: G32

1. Introduction
Most Value-at-Risk (VaR) models focus on the computation of the VaR for negative returns (Jorion (2000)). It is assumed that traders or portfolio managers have long trading position or they bought the asset and are concerned when the price of the asset falls. Since it is common to have short trading

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position, Giot and Laurent (2003) is amongst the first to present the VaR models that are used to model both the long and short sides of daily trading positions. Empirical research shows that stock return distributions can be asymmetric. It means that the left and right tails would have different tickness, implying the usual VaR models of the ARCH class have a tough job in modelling correctly the left and right tails of the distributions of stock returns. To alleviate these problems, we follow Giot and Laurent (2003) to introduce the skewed Student Asymmetric Power ARCH (APARCH) model (Ding et. al. (1993)) to model the one-day-ahead VaR for portfolios of long and short trading positions on Asian stock markets1. In this paper, we consider only the APARCH model as it is a very general ARCH-type model, in that it encompasses RiskMetrics, GARCH and GJR as special cases. We compare the performance of the skewed Student APARCH model by computing Kupiecs (1995) LR tests on the empirical failure rates with the ones of the Student APARCH and the normal models. The result shows that the skewed Student models in general brings about significant improvement in correctly forecasting one-day ahead VaR for both long and short trading positions on ten daily Asian stock index returns (Hong Kong, Singapore, Australia, Korea, Malaysia, Philippines, Thailand, Indonesia, China and Japan), but its performance is not satisfactory in all cases.

For all price series Pt , daily returns (in %) are defined as y t = 100[ln( Pt ) ln( Pt 1 )] . To characterize the APARCH models, we consider a collection of daily returns, y t , with t = 1,2,T, which is known to be conditional heteroscedastic. It is typically modelled as follows: yt = + t and (1) (2)

2. Three competing ARCH-type Models

t = t zt
We now consider several specifications for the conditional variance of t .

2.1 Normal APARCH The normal APARCH (Ding et. al. (1993)) is an extension of the GARCH model of Bollerslev (1986). It is very flexible ARCH-type model as it nests at least seven GARCH specifications. The normal APARCH (1, 1) is defined as: zt ~ i.i.d . N (0,1) (3) and

t = + 1 ( t 1 n t 1 ) + 1 t1

where 1 , n 1 and are parameters to be estimated. ( >0) plays the role of a Box-Cox value of n means that past negative (positive) shocks have a deeper impact on current conditional volatility than past positive shocks (Black (1976), French et. al. (1987)). transformation of

(4)

t , while n (-1< n <1), reflects the so-called leverage effect. A positive (negative)

2.2 Student APARCH Previous empirical studies on VaR forecasts have shown that models based on the normal distribution usually cannot fully take into account the fat tails of the return distribution. To alleviate the problem, the Student APARCH is formulated by using the standardized student distribution (with zero mean, unit variance and degree of freedom)
1

Recently, Giot and Laurent (2003) have shown that the skewed Student APARCH model (unlike the RiskMetrics model or more simple ARCH-type models) does provide more accurate VaR forecasts, both for the right and left tails of the distribution of returns.

137 zt ~ i.i.d . t (0,1, )

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and t is defined as in equation (4).

2.3 Skewed Student APARCH To account for the excess skewness and kurtosis, Fernndez and Steel (1998) propose to extend the Student distribution by adding a skewness parameter2. The innovation process z is said to be (standardized) skewed Student distributed if: m 2 sg[ ( sz + m) ] if z < 1 s + (6) f ( z , ) = 2 m sg[( sz + m) / ] if z s + 1 g ( ) where is the symmetric (unit variance) Student density and is the asymmetry coefficient3. In 2 addition, m and s are respectively the mean and the variance of the non-standardized skewed Student: 1 ( ) 2 1 2 m= ( ) ( ) 2 (7) 1 s 2 = ( 2 + 2 1) m 2 (8) f ( zt 1 , ) = f ( zt , ) Notice also that with respect to the (zero) mean ,Thus, the sign of indicates the direction of the skewness: the third moment is positive (negative), and the density is skewed to the right (left), if ln( ) > 0 (< 0)

For the three competing models, the VaR for long and short positions have been described in Giot and Laurent (2003). They are summarized in the Table 1.

The main weakness of Fernndez and Steel (1998) is that its density is expressed in terms of the mode and the dispersion. In order to keep it in the ARCH tradition, Lambert and Laurent (2001) re-expressed the skewed Student density, in terms of the mean and the variance, in such a way that the innovation process has zero mean and unit variance. The asymmetry coefficient ( >0 ) is defined such that the ratio of probability masses above and below the mean is Pr( z

0 ) Pr( z < 0 ) = 2

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Table 1:

138

VaR for long and short under three competing ARCH-type models St , ( St1 , ) denotes the left (right) quantile at % for the (standardized) Student distribution with
, , 1 , , denotes the left (right) quantile at % (estimated) number of degree of freedom . for the skewed Student distribution with degree of freedom and asymmetry coefficient . Lambert

skst

( skst

and Laurent (2000) show that the quantile function skst density is
skst*, , 1 2 st, 2 (1+ ) = st 1 (1+ 2 ) , 2 if < 1 1+ 2 1 1+ 2

, ,

of a non-standardized skewed Student

if

where , is the quantile function of the (unit variance) Student-t density. It is straightforward to obtain the quantile fuction of the standardized skewed Student:
skst
, ,

St

skst

, ,

a
VaR

ARCH Model Normal APARCH Student APARCH

1

Skewed APARCH2

+ z t + st , t + skst , , t

long

z t + st1 , t + skst1 , , t

Short

3. Data and Empirical Results

The data consist of daily closing prices for the ten major Asia-Pacific equity market indices: Hong Kong Hang-Seng, Singapore Straits Times, Sydney All Ordinaries, Seoul Composite Index, Kuala Lumpur Composite Index, Manila Composite Index, Bangkok Composite Index, Jakarta Composite Index, Tokyo Nikkei 225 and Shanghai B-shares Index. In order to perform the VaR analysis, the normal APARCH, Student APARCH and skewed Student APARCH are estimated first. Table 2 presents the results for the (approximate) maximum likelihood estimation of the skewed Student APARCH model on the ten equity indices4.

We do not report full estimation results of the normal and Student APARCH models as they are quite similar. Furthermore, these specifications are encompassed by the skewed Student APARCH model which we fully detail in Table 2.

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Table 2:

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Estimated Results of the Skewed Student APARCH The t-ratios (t*) are reported in parentheses. Thus, denotes significance at 95% confidence ln( ) < 0 (or < 1) the density is skewed to the left. Thus, the level. is the asymmetry coefficient. If VaR for long positions will be larger (for the same conditional variance) than the VaR for short positions. If ln( ) > 0 (or > 1) , we have the opposite result.
1 0.0687 (7.586) 0.1251 (7.286) 0.0616 (6.068) 0.0729 (4.642) 0.1312 (5.513) 0.1604 (6.018) 0.1149 (5.375) 0.1721 (4.252) 0.2553 (7.816) 0.0712 (7.626) 1 0.9353 (100.216) 0.8776 (46.563) 0.9342 (80.832) 0.9292 (66.116) 0.8852 (38.260) 0.8157 (22.320) 0.8832 (32.912) 0.8562 (23.651) 0.7980 (31.046) 0.9257 (96.261) n 0.4052 (5.376) 0.2309 (4.366) 0.5472 (5.677) 0.2388 (4.154) 0.2230 (4.501) 0.1523 (3.332) 0.1738 (3.548) 0.1354 (3.334) 0.0900 (2.197) 0.4844 (4.554) 1.1808 (7.043) 1.2873 (6.358) 1.1146 (7.196) 1.5704 (7.407) 1.1506 (6.074) 1.4651 (5.632) 1.3760 (5.486) 1.3430 (7.615) 1.1920 (5.993) 1.3296 (6.629) 6.6304 (8.415) 6.7202 (8.759) 10.274 (6.101) 8.507 (6.524) 5.288 (11.477) 5.705 (9.325) 7.360 (8.443) 4.355 (12.502) 3.403 (16.960) 8.337 (7.079) ln() 0.0081 (0.386) 0.011 (0.449) -0.0860 (-3.358) -0.0074 (-0.333) 0.0605 (2.291) 0.0169 (0.674) 0.0881 (3.721) 0.0227 (0.937) 0.0473 (2.117) -0.0169 (-0.682)
t* > 2

Hong Kong Singapore Australia Korea Malaysia Philippines Thailand Indonesia China Japan

0.0182 (2.997) 0.0293 (3.513) 0.0121 (3.290) 0.0207 (2.561) 0.0206 (2.616) 0.0913 (3.211) 0.0486 (2.300) 0.0294 (2.227) 0.0910 (3.643) 0.0231 (3.663)

effects. Second, n is positive and significant for all ten equity indices, indicating a leverage effect for negative returns in the conditional variance specification. Third, are between 1.1146 and 1.5704 and all significantly different from 2. On the other hand ln( ) is significant for only four indices: one (Australia) is negative (the density is skewed to the left) and three (Malaysia, Thailand and China) are positive (the density is skewed to the right) 5. They imply that the asymmetry in the Student distribution is not necessary for all equity indices to fully model the distribution of returns. The estimated parameters based on 1000 returns observations yt are used to forecast the oneday-ahead VaR for observation 1001. For observation 1002, the VaR is forecasted using the same estimated model parameters and return observation y1001 . In this manner, five one-day-ahead VaRs are forecasted before the model parameters are re-estimated. This procedure is repeated until the VaRs of
5

autoregressive effects are strong ( 1 are around 0.9) for eight indices, suggesting strong memory

The ten equity indices feature some relatively similar volatility specifications. First, the

One possible explanation for the density skewed to the right is due to the presence of short-sales restrictions.

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all observations are forecasted. Re-estimating VaR models at every five-day frequency instead of every day does not affect the results but have the benefit of less computation time. 6 All models are tested with a VaR level (which ranged from 5% to 0.5%) and their performance is then assessed by computing the failure rate for the returns, yt If the VaR model is correctly specified, the failure rate should be equal to pre-specified VaR level. Thus, the failure rate is defined as the number of times returns exceed (in absolute value) the forecasted VaR. In our empirical application, we define a failure rate f l ( f s ) for the long (short) trading positions, which is equal to the percentage of negative (positive) returns smaller (larger) than one-step-ahead VaR for long (short) positions. We assess the models performance by first computing their empirical failure rates, both for the left and right tails of the distribution of returns. Because the computation of the empirical failure rate defines a sequence of yes (VaR violation)/ no (no VaR violation) observations, it is possible to test H 0 : f = against H1 : f , where f is the failure rate (estimated by f , the empirical failure

rate), by so-called Kupiec LR test (see Kupiec (1995)). Under the null hypothesis, the LR test statistic (21) is asymptotically distributed as . The p-values for the Kupiecs (1995) LR test on the empirical failure rates for skewed Student (SKST) APARCH, Student (ST) APARCH and normal (N) APARCH are reported in Table 3. The empirical failure rates are also presented in parentheses. The skewed Student APARCH model in general improves on all other specifications for both long and short positions, but its performance is still not satisfactory in all cases. For Australia, Malaysia, Thailand and China, the improvement is substantial as the switch to a skewed Student distribution alleviates all violations (except China). For Hong Kong, Singapore, Korea and Philippines, the Student based (symmetric or skewed) models outperform the normal based model. The symmetric and skewed Student models perform equally well. In Indonesia, even though the Student based models improve the performance of normal based model, the skewed Student model performs even worse than that of symmetric one. For Japan, all three models (normal, Student or skewed Student) correctly model on all VaR levels for long and short positions.

In Giot and Laurent (2003), the VaR models is also estimated at every 5-day frequency.

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Table 3:

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Out-of-sample VaR Results for 10 Equity Indices P-values of Kupiecs (1995) LR test for the null hypotheses f l = ( is the failure rate for the long positions) and( is the failure rate for the short positions). Empirical failure rates are reported in parentheses. They are defined as the number of times returns exceed (in proportion) the forecasted VaR.
Long position 1. 0% 2.5% 0.539 (0.011) 0.681 (0.011) 0.020* (0.015) 0.745 (0.009) 0.450 (0.008) 0.200 (0.013) 0.793 (0.011) 0.793 (0.011) 0.071 (0.014) 0.294 (0.012) 0.294 (0.012) 0.103 (0.014) 0.829 (0.01) 0.392 (0.008) 0.224 (0.013) 0.328 (0.028) 0.471 (0.027) 0.328 (0.028) 0.514 (0.023) 0.514 (0.023) 0.514 (0.023) 0.479 (0.023) 0.135 (0.03) 0.387 (0.028) 0.603 (0.027) 0.797 (0.026) 0.992 (0.025) 0.851 (0.024) 0.250 (0.021) 0.851 (0.024) Short position 99.0% 97.5% 0.275 (0.008) 0.386 (0.008) 0.681 (0.011) 0.230 (0.008) 0.330 (0.008) 0.371 (0.012) 0.313 (0.008) 0.016* (0.005) 0.567 (0.009) 0.407 (0.008) 0. 407 (0.008) 0.807 (0.011) 0.677 (0.009) 0.993 (0.01) 0.007* (0.016) 0.304 (0.022) 0.734 (0.024) 0.555 (0.027) 0.138 (0.02) 0.104 (0.02) 0.229 (0.021) 0.209 (0.021) 0.007* (0.017) 0. 035* (0.019) 0.333 (0.022) 0.211 (0.021) 0.267 (0.021) 0.196 (0.021) 0.851 (0.024) 0.634 (0.027) No. of VaR forecasts 95.0% 0.302 (0.055) 0.161 (0.056) 0.510 (0.053) 0.459 (0.047) 0.868 (0.049) 0.185 (0.044) 0.895 (0.051) 0.311 (0.046) 0.227 (0.045) 0.689 (0.048) 0. 689 (0.048) 0.028* (0.04) 0.251 (0.045) 0.576 (0.047) 0.122 (0.043)

0.5% Hong Kong SKST APARCH ST APARCH N APARCH Singapore SKST APARCH ST APARCH NAPARCH Australia SKST APARCH ST APARCH NAPARCH Korea SKST APARCH ST APARCH N APARCH Malaysia SKST APARCH ST APARCH N APARCH 0.886 (0.005) 0.654 (0.004) 0.006* (0.01) 0.200 (0.007) 0.200 (0. 007) 0.005* (0.01) 0.097 (0.008) 0.016* (0.009) 0.004* (0.01) 0.594 (0.004) 0.398 (0.004) 0.152 (0.007) 0.130 (0.007) 0.210 (0.007) 0.001* (0.01)

5.0% 0.928 (0.05) 0.770 (0.049) 0.241 (0.045) 0.651 (0.048) 0.402 (0.046) 0.011* (0.039) 0.072 (0.042) 0.412 (0.046) 0.133 (0.043) 0.136 (0.057) 0.114 (0.057) 0.935 (0.05) 0.080 (0.042) 0.024* (0.04) 0.003* (0.037)

99.5% 0.273 (0.003) 0.884 (0.005) 0.130 (0.007) 0.819 (0.005) 0.819 (0.005) 0.242 (0.007) 0.578 (0.004) 0.059 (0.003) 0.545 (0.006) 0.863 (0.005) 0.645 (0.006) 0.200 (0.007) 0.074 (0.003) 0.153 (0.003) 0.003* (0.01)

2301

2355

2372

2283

2296

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Table 3: continued
0.5% Philippines SKST APAECH ST APARCH N APARCH Thailand SKST APAECH ST APARCH N APARCH Indonesia SKST APAECH ST APARCH N APARCH China SKST APARCH ST APARCH N APARCH Japan SKST APARCH ST APARCH N APARCH 0.892 (0.005) 0.892 (0.005) 0.126 (0.007) 0.193 (0.007) 0.532 (0.009) 0.155 (0.013) 0.759 (0.024) 0.913 (0.025) 0.717 (0.026) 0.661 (0.048) 0.966 (0.05) 0.464 (0.047) 0.892 (0.005) 0.892 (0.005) 0.316 (0.007) 0.193 (0.007) 0.125 (0.007) 0.404 (0.012) 0.156 (0.021) 0.118 (0.02) 0.156 (0.021) 0.604 (0.052) 0.806 (0.049) 0.185 (0.044) 0.496 (0.004) 0.088 (0.003) 0.000* (0.011) 0.605 (0.009) 0.153 (0.007) 0.001* (0.018) 0.890 (0.025) 0.997 (0.025) 0.590 (0.027) 0.843 (0.051) 0.774 (0.049) 0.138 (0.043) 0.034* (0.008) 0.034* (0.008) 0.000* (0.016) 0.179 (0.013) 0.124 (0.013) 0.000* (0.022) 0.285 (0.029) 0.115 (0.03) 0.014 (0.033) 0.011* (0.062) 0.001* (0.066) 0.498 (0.053) 0.304 (0.007) 0.119 (0.007) 0.000* (0.012) 0.502 (0.011) 0.639 (0.011) 0.002* (0.017) 0.038* (0.032) 0.088 (0.031) 0.038* (0.032) 0.046* (0.059) 0.086 (0.058) 0.649 (0.048) 0.636 (0.006) 0.912 (0.005) 0.000* (0.012) 0.502 (0.011) 0.383 (0.012) 0.017* (0.015) 0.774 (0.026) 0.984 (0.025) 0.878 (0.026) 0.752 (0.051) 0.548 (0.053) 0.397 (0.046) 0.636 (0.006) 0.465 (0.004) 0.636 (0.006) 0.956 (0.01) 0.047* (0.006) 0.956 (0.01) 0.700 (0.024) 0.017* (0.018) 0.099 (0.02) 0.179 (0.044) 0.010* (0.039) 0.018* (0.04) 0.636 (0.006) 0.304 (0.007) 0.002* (0.01) 0.205 (0.007) 0.875 (0.01) 0.027* (0.015) 0.132 (0.02) 0.909 (0.025) 0.675 (0.026) 0.296 (0.045) 0. 613 (0.052) 0.397 (0.046) 0.682 (0.006) 0.490 (0.006) 0.006* (0.009) 0.704 (0.011) 0.862 (0.01) 0.008* (0.016) 0.070 (0.031) 0.092 (0.031) 0.119 (0.03) 0.337 (0.054) 0.386 (0.054) 0.577 (0.047) 0.863 (0.048) 0.429 (0.004) 0.003* (0.01) 0.704 (0.025) 0.973 (0.01) 0.008* (0.016) 0.904 (0.011) 0.781 (0.026) 0.884 (0.025) 0.645 (0.005) 0.716 (0.048) 0.019* (0.04) Long position 1. 0% 2.5% 5.0% 99.5% Short position 99.0% 97.5%

142

No. of VaR forecasts 95.0%

2316

2274

2274

2239

2291

4. Summary
The performance of VaR forecasts by three competing modelsnormal APARCH, Student APARCH and skewed Student APARCH is investigated by using daily returns of ten Asian equity indices. We apply the Kupiecs LR tests of proportional failure rates to such VaR models. The results show that the skewed Student APARCH model in general outperforms all other specifications for both long and short positions.

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International Research Journal of Finance and Economics - Issue 22 (2008) Black, F. 1976. Studies of stock market volatility changes. Proceedings of the American Statistical Association, Business and Economic Statistics Section, pp.177-181. Bollerslev, T. 1986. Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics 31, pp.307-327. Ding, Z, Granger, C.W.J. and Engle R.F. 1993. A long memory property of stock market returns and a new model. Journal of Empirical Finance 1, pp.83-106. Fernndez, C. and Steel, M.F.J. 1998. On Bayesian modelling of fat tails and skewness. Journal of the American Statistical Association 93, pp.359-371. French, K.R. and Schwert, G..W. and Stambaugh, R.F. 1987. Expected stock returns and volatility. Journal of Financial Economics 19, pp.3-29. Giot, P. and S. Laurent, 2003. Value-at-risk for long and short trading positions. Journal of Applied Econometrics 18, pp.641-664. Jorion, P. 2000. Value-at-Risk: The New Benchmark for Managina Financial Risk. McGrawHill: New York. Kroner FK, Ng VK. 1998. Modelling asymmetric comovements of asset returns. The Review of Financial Studies 11, pp. 817-844. Kupiec, P. 1995. Techniques for verifying the accuracy of risk measurement models. Journal of Derivatives 2, pp.174-184. Lambert, P. and Laurent, S. 2000. Modelling skewness dynamics in series of financial data. Discussion Paper, Institut de Statistique, Louvain-la-Neuve. Lambert, P. and Laurent, S. 2001. Modelling financial time series using GARCH-type models and a skewed Student density. Mimeo, Universit de Lige.

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