Lecture 5 M4

QBUS6830 (S2, 2022); Module 4; Week 13 1
Module 4: Forecasting and Risk Management

References:
• Engle, R. F. and Manganelli, S. (2004), “CAViaR: Conditional autoregressive
value at risk by regression quantiles.” Journal of Business and Economic Statis-
tics, 22, p367-381.
• Hansen P.R., Huang, Z. and Shek, H. (2012), “Realized GARCH: a joint model for
returns and realized measures of volatility” Journal of Applied Econometrics,
27, 6, p 877-906
• Gerlach, R and Chen, CWS (2016), “Bayesian Expected Shortfall Forecasting
Incorporating the Intra-day Range”, Journal of Financial Econometrics, 14, 1,
128-158.
• Gerlach, R, Walpole, D and Wang, C. (2017) “Semi-parametric Bayesian Tail
Risk Forecasting Incorporating Realized Measures of Volatility”, Quantitative
Finance, 17, 2, 199-215.
Models incorporating and modelling realized intra-day measures

• Volatility proxies are well known to be at least 5 times more efficient than squared
(or absolute) daily returns, at estimating unobserved volatility.
• We have employed 5 volatility proxies to assess how well models could forecast
volatility
• The parametric GARCH models used squared daily returns as an input to inform
us about the next day’s unobserved volatility.
• The GARCH-X models employ more efficient volatility proxies as inputs to volatil-
ity, instead of squared returns.
• We can do this with semi-parametric CaViaR models too.

• Further, we can ”complete” the GARCH-X model by modelling the contempora-

neous relationship between latent volatility and the realized measure.
• This was proposed by Hansen et al (2012) who named this model Realized GARCH.
• The Realized GARCH model adds a measurement equation to the usual GARCH-
X model: this is an equation modelling Xt itself, as a function of σt and a random
error.
• This measurement equation for the realized measure allows h > 1 multi-step-
ahead forecasts of volatility and tail risk, which are not possible under GARCH-X
models.
• These models can lead to significant increases in volatility and/or tail risk fore-
casting accuracy ... sometimes.
• In this lecture we focus on the CaViaR-X model and the Realized GARCH model;
there are literally hundreds of others!!
CaViaR-X models
• Adding a ’-X’ to a CaViaR model indicates that an exogenous regression variable
’X’ is being included, instead of (absolute) daily returns.
• We can add a realized measure directly into the quantile equation.
• A simple extension of the CaViaR (SAV) idea, first appearing in Walpole (2013;
Honours thesis) and then as CaViaR-X in Gerlach and Chen (2016) is:
Qt+1,α = β0 + β2Xt + β1Qt,α
• Where Qt,α is the α level conditional 1 step ahead quantile for the return rt, i.e.
α = P r(rt+1 < Qt+1,α|Ft)
√
• Xt on the standard deviation scale, e.g. Xt = RVt, is employed since Xt2 is on
the scale of the variance, but quantiles are on the scale of standard deviation, so
square root is applied.
• Quantile loss-based estimation can proceed in exactly the same way as for standard
CaViaR models.
• Only h = 1 step-ahead forecasts can be generated for VaR under this model.
• This is because at time t we have not observed Xt+1, ...Xt+h−1 and so cannot
estimate Qt+k , k > 1, or even simulate rt+1, rt+2|Ft, since this would require
Xt+1 which is not in Ft
• To generate h > 1 step ahead forecasts, we would need to also have a model for
Xt, to forecast Xt+k |Ft, k ≥ 1; see e.g. Realized GARCH model, Hansen et al
(2012, Journal of Applied Econometrics)
• The only parameter restriction is |β1| < 1
• Since the model does not specify a distribution for rt or Xt, nor a relationship
between Qt and Xt, we cannot guarantee stationarity in this model (just like the
CaViaR model).
CaViaR-X models: example

• CBA returns from January, 2000 to March, 2018 were estimated by CaViaR and
CaViaR-X models at 2.5% and 1% risk levels.
• The estimates for the standard CaViaR quantile equations are:

Qt+1;0.025 = − 0.018 + 0.926 Qt;p − 0.172 |r|t
Qt+1;0.01 = − 0.050 + 0.900 Qt;p − 0.269 |r|t
• The estimated CaViaR-X quantile equations are:

Qt+1;0.025 =0.025 + 0.871 Qt;0.025 − 0.358 Xt
Qt+1;0.01 = − 0.036 + 0.839 Qt;0.01 − 0.470 Xt
√
when Xt is set to RVt, and
Qt+1;0.025 =0.0038 + 0.876 Qt;0.025 − 0.344 Xt
Qt+1;0.01 = − 0.033 + 0.879 Qt;0.01 − 0.367 Xt
when Xt is set to Proxy 2t, the scaled intra-day range: ’Ra’.
• Of note here:
√
1. The β2 values, estimating the effect of today’s realized measure X t on tomor-
row’s quantile Qt+1 are much bigger than those when using today’s absolute
return rt, for both RV and Ra
2. The effect of today’s RV is higher, than that of today’s scaled intra-day range
Ra, on tomorrow’s quantile Qt+1.
3. The β1 values, estimating the effect of today’s quantile Qt on tomorrow’s quan-

tile Qt+1 are slightly lower in the CaViaR-X models than those in standard
CaViaR models.
4. The estimate of β1 when using RV is marginally smaller than that when using
the range proxy.
5. The estimates of β1 for p = 0.025 are consistently smaller in magnitude than
those when p = 0.01
• The higher β2 and lower β1 estimates when using RV may indicate that today’s
RVt contains more information about Qt+1 than the range or absolute returns do.
• The higher β2 and lower β1 estimates when using Ra may indicate that today’s
Rat contains more information about Qt+1 than the absolute returns do.
• The higher magnitude β1 estimates as p gets smaller indicate that the more ex-
treme tail quantiles are more strongly affected by today’s RV or Ra or absolute
return, compared to less extreme quantiles.
• In-sample conditional 1% quantile estimates from these models are shown in Fig-
ure 1
• Both quantile series for the CaViaR-X model seem less smooth than that for the
CaViaR model.
• This is due to the higher β2 and lower β1 estimates when using RV, compared to
those of when using absolute returns.
• Across the 3 CaViaR models, at the 1% risk level the in-sample quantile loss
function values are: 159.9, 161.8 and 159.1, for CaViaR, CaViaR-RV and CaViaR-
Ra respectively.
• At the 2.5% risk level the in-sample quantile loss function values are: 357.7, 357.2
and 352.6, for CaViaR, CaViaR-RV and CaViaR-Ra respectively.
• Using Proxy 2’s intra-day range is the most accurate model in-sample for 1% (and
2.5%) VaR for the CaViaR(-X) models; i.e. it is closest to the true 1% (and 2.5%)
VaR series for CBA.
• Since the CaViaR-type models are estimated by specifically minimising the quan-
tile loss function, I would expect: CaViaR to have lowest quantile loss for models
employing returns, CaViaR-RV to have lowest loss for models employing RV and
CaViaR-Ra to have lowest loss for models employing Ra.
• Indeed the GARCH-t, GARCH-RV-t and GARCH-Ra-t models have quantile

losses for their 1% VaR in-sample estimates of: 168.2, 165.1 and 157.1 respectively.
• However, the GARCH-t, GARCH-RV-t and GARCH-Ra-t models also have quan-
tile losses for their 2.5% VaR in-sample estimates of: 392.1, 344.8 (lower than
CaViaR-RV) and 334.0 (lower than CaViaR-Ra) respectively.
• In-sample, the GARCH-Ra-t has lowest quantile loss for its estimated 2.5% VaR
series among the GARCH(-x) and CaViaR(-X) models so far.
• In-sample, the CaViaR-Ra has lowest quantile loss for its estimated 1% VaR series
among the GARCH(-X) and CaViaR(-X) models so far.
CBA: In-sample 1% VaR estimates

CaViaR
10
CaViaR-RV
CaViaR-Ra
10
2002 2004 2006 2008 2010 2012 2014 2016 2018
Figure 1: In-sample conditional 1% VaR estimates: CaViaR(-X).

Realized GARCH models

• The GARCH-X model is usually written as:
rt = µt + at; at = σtϵt
σt2 = α0 + α1Xt−1
2 2
+ β1σt−1
where ϵt ∼ D1(0, 1) and is i.i.d.
• Hansen et al (2012) proposed to add a 3rd equation, a so-called measurement

equation, to ”complete” this model.
• The simplest measurement equation they proposed is:

Xt2 = ξ + ψσt2 + ut
where ut ∼ D2(0, τu2) and is i.i.d.
• The model can also include asymmetry terms, but I leave these out, for simplicity.
• This measurement equation basically allows for the realized measure Xt2 to be a
noisy estimate of σt2, with ut the ”measurement error”.
• An unbiased realized measure would have ξ = 0, ψ = 1, i.e. E(Xt2) = E(σt2)
• This Realized GARCH model is then:

σt2 = α0 + α1Xt−1
2 2
+ β1σt−1
Xt2 = ξ + ψσt2 + ut
• We employ D1 ≡ N or t∗ and D2 ≡ N (0, τu2) here, which are the standard choices.
• It is also common, and recommend by Hansen et al (2012), to model the logarithms

of the variance and realized measure.
• This makes the optimization procedure for parameter estimation more stable.
• This Realized Exponential GARCH model is then:

log(σt2) = α0 + α1 log(Xt−1
2 2
) + β1 log(σt−1 )
log(Xt2) = ξ + ψ log(σt2) + ut
• This is the specification I will illustrate today.
• Parameter restrictions for stationarity are are: |α1ψ + β1| < 1

• this is because log(Xt−1

2 2
) = ξ + ψ log(σt−1 ) + ut−1 and so we can write:
log(σt2) = α0 + α1(ξ + ψ log(σt−1
2 2
) + ut−1) + β1 log(σt−1 )
2
= α0 + α1ξ + (α1ψ + β1) log(σt−1 ) + α1ut−1
• Hence the Re-GARCH volatility equation is like a stochastic AR(1) model for
log(σt2)
• An unbiased log realized measure would have ξ = 0, ψ = 1, i.e. then E(log Xt2) =
E(log σt2). This is not usual, or even desired.
• However, since exp E(log Xt ) ̸= E exp(log Xt ) = E(Xt2), ξ = 0, ψ = 1 in

2
2

the Re-Exp-GARCH model does not indicate an unbiased realized measure.
• In fact, we know that exp E(log Xt ) < E exp(log Xt ) , so ξ = 0, ψ = 1 in the

2
2

Re-Exp-GARCH model would indicate a biased realized measure.
• Specifically, we expect ξ < 0 for a minimally biased, i.e. close to unbiased, realized
measure.
• For the Re-GARCH model, τu2 = V ar(Xt2|σt2), which is an inverse measure of the
efficiency of a realized measure: it is like SER2 in a regression model.
• For the Re-Exp-GARCH model, τu2 = V ar(log Xt2| log σt2), which is (still) an
inverse measure of the efficiency of a realized measure.
• Estimation is done by maximum likelihood, where:

T
Y
p(r, log X|θ) = p(rt, log Xt|Ft−1)
t=1
YT
= p(rt|Ft−1)p(log Xt|rt, Ft−1)
t=1
where rt|Ft−1 ∼ D1(µt, σt2) and log Xt|rt, Ft−1 ∼ N (ξ + ψ logσt2, τu2)
• The likelihood is now the joint probability density function of the observed returns
and the observed realized measure.
Realized GARCH models: example

• CBA returns from Jan, 2000 to Sept, 2017 were estimated by GARCH-t, GARCH-
X-t and Realized GARCH-t-N models with constant means.
• The estimated GARCH-t variance equation is:

2
σt+1 = 0.014 + 0.049a2t + 0.945σt2
• The estimated GARCH-X-t variance equation is

2
σt+1 = 0.011 + 0.428Xt2 + 0.713σt2
2
σt+1 = 0.0007 + 0.234Xt2 + 0.857σt2
when Xt is set to Proxy 2t, the scaled intra-day range (’Ra’) squared.
• The estimated Realized GARCH-t-N variance equation is

2
log σt+1 = 0.146 + 0.273 log Xt2 + 0.745 log σt2
2
log σt+1 = 0.160 + 0.211 log Xt2 + 0.790 log σt2
when Xt is set to Proxy 2t, the scaled intra-day range (’Ra’) squared.
• The table below shows the parameter estimates for all these models:
• Of note here:
1. The α1 values for GARCH-X models, estimating the effect of today’s realized
measure Xt2 on tomorrow’s variance σt+12
are much bigger than those we usually
see for the effect of today’s squared shock a2t .
2. The α1 values for Re-GARCH models, estimating the effect of today’s logged
realized measure log Xt2 on tomorrow’s logged variance log σt+1
2
are also much
bigger than those we usually see for the effect of today’s squared shock a2t .
Table 1: The GARCH, GARCH-X and Re-GARCH parameter estimates for CBA
Model α1 , β2 β1 Persistence ν ξ ψ τu2

GARCH-N 0.052 0.939 0.991 6.09
GARCH-RV 0.477 0.679
GARCH-Ra 0.267 0.832
Re-G-RV 0.270 0.743 0.980 -0.521 0.879 0.554
Re-G-Ra 0.188 0.804 0.979 -0.747 0.930 0.771
GARCH-t 0.075 0.917 0.992
GARCH-RV-t 0.428 0.713 8.69
GARCH-Ra-t 0.234 0.857 9.13
Re-G-RV-t 0.273 0.745 0.980 8.98 -0.518 0.862 0.554
Re-G-Ra-t 0.211 0.790 0.976 8.41 -0.731 0.883 0.767
3. The effect of today’s RV is higher, than that of today’s scaled intra-day range
2
squared, on tomorrow’s (logged) variance σt+1 .
4. The β1 values, estimating the effect of today’s (logged) variance σt2 on tomor-
2
row’s σt+1 are lower in GARCH-X and Realized GARCH models than they are
in standard GARCH models.
5. The estimate of β1 when using RV is smaller than that when using the range
proxy and that when using squared shocks.
• The higher α1 and lower β1 estimates when using RV may indicate that to-
2
day’s RVt contains more information about σt+1 than both the intra-day range or
squared shocks do.
• The higher α1 and lower β1 estimates when using Proxy 2 may indicate that
2
today’s Rat contains more information about σt+1 than the squared shocks do.
• In-sample conditional volatility estimates from these models are shown in Figures
2 and 3
• Both volatility series for the GARCH-X model seem less smooth than that for the
GARCH(1,1) model.
• This is due to the higher α1 and lower β1 estimates when using RV, compared to
those of the GARCH using squared shocks.
• The Realized GARCH volatility series seem nearly as smooth as the GARCH
model’s; further, it lessens or dampens the effects of the large extreme RV values
that cause large shocks in the GARCH-RV volatility series (in 2004-2005).
• In-sample 1% VaR estimated series for GARCH-t, GARCH-X-t and Realized

GARCH-t models are shown in figure 4
• The more extreme GARCH-RV-t volatility estimates in 2004-2005 give rise to

some extreme 1% VaR estimates for that model for the same days.
• Again the Realized GARCH-t model’s VaR estimates smooth these out.
• The Re-GARCH-N-RV, Re-GARCH-N-Ra, Re-GARCH-t-RV, Re-GARCH-t-Ra

models have quantile losses for their 1% VaR in-sample estimates of: 162.3, 162.8,
161.0 and 161.4 respectively.
In-sample volatility estimates

GARCH-N
G-Ra-N
10 G-RV-N
Re-GARCH-N-RV
Re-GARCH-N-Ra
10
2002 2004 2006 2008 2010 2012 2014 2016 2018
Figure 2: In-sample conditional volatility estimates: Gaussian models.
• In-sample, the CaViaR-Ra still has the lowest quantile loss for its estimated 1%
VaR series among the GARCH(-X) and CaViaR(-X) models so far.
CBA: In-sample volatility estimates, Student-t

GARCH-t
GARCH-Ra-t
10 GARCH-RV-t
Re-GARCH-t-N-RV
Re-GARCH-t-N-Ra
5
10
15
2002 2004 2006 2008 2010 2012 2014 2016 2018
Figure 3: In-sample conditional volatility estimates: Student-t models.
• The Re-GARCH-N-RV, Re-GARCH-N-Ra, Re-GARCH-t-RV, Re-GARCH-t-Ra

models have quantile losses for their 2.5% VaR in-sample estimates of: 347.6,
CBA: In-sample 1% VaR estimates, Student-t

GARCH-t
10 G-RV-t
G-Ra-t
Re-G-t-RV
Re-G-t-Ra
5
10
15
2002 2004 2006 2008 2010 2012 2014 2016 2018
Figure 4: In-sample conditional 1% VaR estimates: Student-t models.
357.6, 345.6 and 356.7 respectively.

• In-sample, the GARCH-Ra-t still has lowest quantile loss for its estimated 2.5%
VaR series among the GARCH(-X) and CaViaR(-X) models so far.
Example: 1 step-ahead volatility forecasting

• CBA returns from Jan, 2000 to March, 2018 were used as the initial in-sample
period to generate 1-step-ahead volatility forecasts for the last 1000 days in the
sample.
• GARCH, GARCH-X, GJR, EGARCH and Realized GARCH models are em-
ployed, with both Gaussian and Student-t errors in the observation or mean
equation.
• Also, the RM, HS-100 and HS-T methods were employed.
• Parameters are re-estimated every 25 days. This took several hours on my laptop,
due to the Realized GARCH models taking very long to optimize.
• Figure 5 shows the 1-step-ahead volatility forecasts for the GARCH-t, GARCH-
RV-N, GARCH-Ra-N, Re-G-N-RV and Re-G-N-Ra volatility models for CBA.
• Both Realized GARCH-N models have apparently reacted much more to the high
volatility days in March 2020, than the other models.
• Figure 6 shows the 1-step-ahead volatility forecasts for the GARCH-t, GARCH-
RV-N, GARCH-Ra-N, Re-G-N-RV and Re-G-N-Ra volatility models for CBA.
• All GARCH-X and Realized GARCH models have apparently reacted similarly
to a GARCH-t to the start of the high volatility days in March 2020. However,
these models recover much faster than the GARCH-t (which has significant white
space below its forecasts in mid-2020)
• Similar comments apply for the GARCH-X-t and Re-GARCH-t models forecasts.
Proxy 2
G-RV-N
8 G-t
G-Ra-N
Re-G-N-RV
Re-G-N-Ra
6
0
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 5: 1 step ahead forecasts of volatility for CBA in last 1000 days, plus Proxy 2.
8
Proxy 5
G-RV-t
7 G-t
G-Ra-t
Re-G-t-RV
6 Re-G-t-Ra
0
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 6: 1 step ahead forecasts of volatility for CBA in last 1000 days, plus proxy 5.
• Compared to those, the GARCH-t forecasts are sometimes somewhat similar, but
sometimes differ, mainly following unexpectedly large magnitude returns, where
the GARCH-t forecasts take longer to ”recover” or re-connect with the volatility
proxy.
• Table 2 (CBA) shows the forecast accuracy for the 1-step-ahead volatility forecast
from all models, using RMSE.
• Table 3 (CBA) shows the forecast accuracy for the 1-step-ahead volatility forecast
from all models, using MAD.
• The table shows forecast accuracy for σt(1) under each model, for t = T, . . . , T +
999, i.e. 1000 1-day-ahead forecasts.
• The forecast accuracy numbers are reasonably consistent across the proxies and
both RMSE and MAD.
Table 2: The 1-step ahead forecast accuracy by RMSE for all models/methods for CBA
Model Proxy 1 Proxy 2 Proxy 3 Proxy 4 Proxy 5

ARCH 1.0763 0.7096 0.6874 0.6784 0.6529
GARCH 1.1146 0.7273 0.7123 0.7065 0.6549
GJR 1.0974 0.7128 0.6915 0.6874 0.6459
EGARCH 1.0758 0.6652 0.6651 0.6552 0.5801
RM 1.1658 0.8003 0.7824 0.7792 0.7309
GARCH-RV 1.0259 0.5954 0.6466 0.6231 0.4801
GARCH-Ra 1.0447 0.6681 0.6404 0.6371 0.5977
Re-G-N-RV 1.0550 0.6355 0.6740 0.6572 0.5258
Re-G-N-Ra 1.0611 0.6539 0.6553 0.6463 0.5592
ARCH-t 1.0765 0.7094 0.6871 0.6780 0.6528
GARCH-t 1.1322 0.7498 0.7354 0.7300 0.6769
GJR-t 1.1165 0.7361 0.7155 0.7118 0.6683
EGARCH-t 1.0941 0.6919 0.6869 0.6792 0.6096
GARCH-RV-t 1.0288 0.5978 0.6493 0.6258 0.4829
GARCH-Ra-t 1.0682 0.6842 0.6609 0.6589 0.6045
Re-G-t-RV 1.0600 0.6853 0.6575 0.6552 0.6151
Re-G-t-Ra 1.0599 0.6491 0.6792 0.6649 0.5453
HS-100 1.2979 0.9580 0.9755 0.9711 0.8624
HS-T 1.2557 0.8622 0.9553 0.9237 0.7366
• The GARCH-RV-N or GARCH-RV-t is always the most accurate volatility fore-

casting model, with lowest variation measure for each proxy and RMSE, MAD
combination.
Table 3: The 1-step ahead forecast accuracy by MAD for all models for CBA
Model Proxy 1 Proxy 2 Proxy 3 Proxy 4 Proxy 5

ARCH 0.7789 0.5147 0.4707 0.4710 0.4666
GARCH 0.7946 0.5315 0.4775 0.4765 0.4760
GJR 0.7893 0.5205 0.4675 0.4688 0.4670
EGARCH 0.7748 0.5047 0.4507 0.4506 0.4482
RM 0.8179 0.5644 0.5100 0.5118 0.5093
GARCH-RV 0.7072 0.4243 0.4083 0.3975 0.3471
GARCH-Ra 0.7430 0.4734 0.4230 0.4191 0.4222
Re-G-N-RV 0.7225 0.4371 0.4167 0.4064 0.3640
Re-G-N-Ra 0.7499 0.4767 0.4299 0.4233 0.4183
ARCH-t 0.7797 0.5170 0.4720 0.4723 0.4690
GARCH-t 0.8043 0.5446 0.4900 0.4887 0.4889
GJR-t 0.7994 0.5342 0.4813 0.4812 0.4799
EGARCH-t 0.7840 0.5162 0.4613 0.4607 0.4610
GARCH-RV-t 0.7083 0.4250 0.4090 0.3978 0.3475
GARCH-Ra-t 0.7554 0.4862 0.4353 0.4292 0.4328
Re-G-t-RV 0.7501 0.4812 0.4316 0.4267 0.4292
Re-G-t-Ra 0.7251 0.4414 0.4189 0.4092 0.3687
HS-100 0.8755 0.6523 0.5963 0.5997 0.5937
HS-T 0.8730 0.6479 0.6081 0.5981 0.5990
• The HS-T is always the least accurate volatility forecasting model.
• If we rank each model in each row above, from minimum (1) (best) to maximum
(19) (worst), the average ranks for each model under RMSE and MAD are:
Table 4: Forecast accuracy mean rankings for the 19 1-step forecast models for CBA
Measure RMSE MAD

ARCH 11.6 11.0
GARCH 14.0 14.0
GJR 12.6 12.0
EGARCH 6.6 9.0
RM 17.0 17.0
GARCH-RV 1.2 1.0
GARCH-Ra 4.2 5.2
Re-G-N-RV 5.0 3.0
Re-G-N-Ra 5.0 5.8
ARCH-t 11.0 12.4
GARCH-t 16.0 16.0
GJR-t 15.0 15.0
EGARCH-t 10.6 10.6
GARCH-RV-t 2.2 2.0
GARCH-Ra-t 7.6 8.0
Re-G-t-RV 7.2 7.0
Re-G-t-Ra 6.2 4.0
HS-100 19.0 18.6
HS-T 18.0 18.4
• There is again quite some consistency in the ranking of models.
• The GARCH-RV-N and GARCH-RV-t consistently rank in the top 2 places for
MAD and RMSE; though GARCH-RV-t is ranked 3rd for MAD for proxy 3.
• The adhoc HS-T and HS-100 methods consistently rank in positions 18 and 19;
RM always ranks in 17th place too. These are always the 3 least accurate 1-day
volatility forecast methods for CBA.
• The 16 formal, parametric GARCH(-X)-type and Re-GARCH models always fin-

ish 1st-16th in accuracy, for each proxy and RMSE, MAD.
• Under RMSE, the top 5 ranked models are: GARCH-RV-N (always 1st or 2nd),
GARCH-RV-t (always 2nd or 3rd), GARCH-Ra-N (1st, 3rd or 7th), Re-G-N-
Ra (4th-7th), with Re-G-N-RV (3rd-11th) and Re-G-t-RV (4th-10th) tied for 5th
place.
• Under MAD, the top 5 ranked models are: GARCH-RV-N (1st or 2nd), GARCH-
RV-t (1st or 2nd), Re-G-N-RV (always 3rd), Re-G-t-Ra (always 4th) and GARCH-
Ra-N (always 5th).
• The EGARCH-N, Re-G-t-Ra, ARCH-N and ARCH-t are typically the next 4
highest ranked models under RMSE, making a top 10 model list under RMSE.
• The Re-G-t-RV, Re-G-N-Ra, GARCH-Ra-t, EGARCH-N and GJR-N are typi-

cally the next 5 highest ranked models under MAD, making a top 10 model list
under MAD.
• Under both RMSE and MAD, the top 6 most accurate forecasters of 1 day volatil-
ity are GARCH-X or Re-GARCH models.
• All 8 GARCH-X and Re-GARCH models are in the top 10 models under RMSE,
whilst 7 of the 8 are in the top 10 models under MAD (and GARCH-Ra-t ranks
11th).
• Clearly, the realized measures RV and Range (proxy 2) have added significant
additional information, over squared daily returns, that can assist in generating
more accurate 1-step-ahead volatility forecasts for CBA.
• This seems especially true for the GARCH-RV-N and GARCH-RV-t specifications.
• It is quite usual that realized measures such as RV and Range improve volatility
forecasting accuracy over using daily returns only.
• Despite the enormous popularity of RV, the intra-day range sometimes outper-
forms it in forecasting volatility.
• Is the ”complicated” hard work of time series modelling of volatility, plus finding
and extracting, storing, cleaning, etc the volumes of the intra-day data, worth the
effort?
• Discussion
Tail risk forecasting 1-step-ahead

• In lectures 2 and 3 of module 4 we found that many of the standard GARCH
models, indeed almost all models we tried, were mostly rejected as accurate 1-
day-ahead VaR and ES forecast models.
• This is where the financial time series literature was at about a decade ago.
• Hundreds more volatility models, different error distributions, different types of
nonlinearity, etc were tried, yielding mostly only small gains in accuracy of tail
risk forecasts.
• Then, we tried using realized measures in models, e.g. GARCH-X and CaViaR-X
and also Realized GARCH models (plus many others). Here is what we found . . .
Example: Tail risk forecasting 1-step-ahead

• CBA returns from Jan, 2000 to March, 2018 were used as the initial in-sample
period to generate 1-step-ahead volatility, VaR and ES forecasts for the last 1000
days in the sample.
• GARCH, GARCH-X, GJR, EGARCH and Realized GARCH models are em-
ployed, with both Gaussian and Student-t errors.
• CaViaR and CaViaR-X models were also employed.
• Also, the RM, HS-100 and HS-T methods were employed.
• Parameters are re-estimated every 25 days; this took several hours on my laptop;
mainly due to the Realized GARCH model.
• Figure 7 shows the 1-step-ahead VaR 2.5% forecasts for several of the models for
CBA.
• Figure 8 shows the 1-step-ahead VaR 2.5% forecasts for the CaViaR models.
• Figure 9 shows the 1-step-ahead VaR 1% forecasts for several of the models.
2.5% VaR Forecasts of Some Models

CBA returns HS(T) CaViaR GARCH-RV-t
GARCH-t HS(100) CaViaR-RV Re-G-RV-N
EG-t
10
10
15
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 7: 1 step ahead forecasts of VaR 2.5% for CBA in last 1000 days.
2.5% VaR Forecasts of CaViaR Models

CBA returns CaViaR CaViaR-Ra CaViaR-RV
10
10
15
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 8: 1-period-ahead forecast VaRs for p = 0.025 for CBA returns from 3 CaViaR(-X) models
1% VaR Forecasts of Many Models

CBA returns HS(T) CaViaR GARCH-X-t
GARCH-t HS(100) CaViaR-X Re-G-RV-t
EG-t
10
10
15
20
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 9: 1 step ahead forecasts of VaR 1% for CBA in last 1000 days.
• Figure 10 shows the 1-step-ahead VaR 1% forecasts for the GARCH-t, GARCH-
RV-t and GARCH-Ra-t models.
• Table shows the VaR 2.5% forecasting summary for all the models
Table 5: The 1-step-ahead forecast VaR summary for all models for CBA, last 1000 days, for p = 0.025.
Model A G GJR EG RM G-RV G-Ra Re-G-N-RV Re-G-N-Ra HS-T HS-100

Violations (25) 37 33 36 35 30 47 36 43 33 27 35
α̂ 0.037 0.033 0.036 0.035 0.030 0.047 0.036 0.043 0.033 0.027 0.035
α̂
α
1.48 1.32 1.44 1.40 1.20 1.88 1.44 1.72 1.32 1.08 1.40
p-valU C 0.015 0.105 0.026 0.043 0.311 0.000 0.026 0.0003 0.105 0.685 0.043
p-valind 0.731 0.115 0.044 0.036 0.068 0.024 0.180 0.042 0.115 0.037 0.036
p-valDQ 0.028 0.044 0.008 0.007 0.003 0.000 0.030 0.000 0.043 0.000 0.000
Loss 97.85 102.00 100.33 100.22 105.09 101.12 95.28 103.47 96.95 128.76 119.71
Model A-t G-t GJR-t EG-t CAV CAV-RV CAV-Ra G-RV-t G-Ra-t Re-G-t-RV Re-G-t-Ra
Violations (25) 34 30 36 31 31 43 32 47 36 45 34
α̂ 0.034 0.030 0.036 0.031 0.031 0.043 0.032 0.047 0.036 0.045 0.034
α̂
α
1.36 1.20 1.44 1.24 1.24 1.72 1.28 1.88 1.44 1.80 1.36
p-valU C 0.068 0.311 0.026 0.2243 0.2243 0.000 0.156 0.000 0.026 0.000 0.0683
p-valind 0.877 0.068 0.044 0.015 0.081 0.147 0.097 0.024 0.180 0.016 0.134
p-valDQ 0.100 0.023 0.007 0.002 0.007 0.000 0.131 0.000 0.127 0.000 0.159
Loss 97.28 102.86 101.30 101.23 102.84 105.85 98.49 101.03 95.78 103.90 95.87
• For p = 0.025 the HS-T has the closest to a VRate of 2.5%, whilst the GARCH-
1% VaR Forecasts of (Re-) GARCH (-X) Models

CBA returns GARCH-Ra-t GARCH-RV-t Re-G-RV-t
GARCH-t
10
10
15
20
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 10: 1-period-ahead forecast VaRs for p = 0.01 for CBA returns from 3 CaViaR(-X) models
N, RM, Re-GARCH-N-Ra, HS-100, ARCH-t, GARCH-t, CaViaR, CaV-Ra and

Re-GARCH-t-Ra models have their VRates also not significntly from p = 0.025,
via the UC test.
• On the other hand, all other models fail the UC test and have violation rates
significantly above 0.025.
• Once again, no models have too few violations or have VRates significantly below
2.5%.
• Almost all models, as expected, are rejected by either or both of the independence
and/or DQ tests. The only exceptions, or surviving models from these 2 tests, are
the ARCH-t, CaV-Ra, GARCH-Ra-t and Re-G-Ra-t models.
• Given the accuracy of the GARCH-RV models in volatility forecasting, it is sur-
prising to see both of these rejected by all three tests for 2.5% VaR forecasting!
• The 2 GARCH-Ra models have the lowest quantile loss values, but both are
rejected by the UC test with too many violations.
• Only the ARCH-t, CaV-Ra and Re-G-Ra-t models do not get rejected by any of
the 3 tests.
• Of these remaining models, the Re-GARCH-Ra-t model ranks as the best VaR
forecast model by minimum quantile loss measure; i.e. it has the closest VaR 2.5%
forecast series to the true VaR 2.5% series.
• Further, each model that employed both RV and Ra (CaViaR-X, GARCH-X,
Re-G), had the version using Ra’s forecasts return lower observed quantile loss.
• The Intra-day range has performed very well at allowing (more) accurate VaR
2.5% forecasts for CBA.
• For the parametric models, Gaussian or Student-t errors give very similar results.
• The HS-100 and HS-T models were the least accurate in forecasting 2.5% VaR for
CBA, with the 2 highest quantile loss values, well above all other models.
• Discussion
• Violations for p = 0.025 are shown in Figure 11

2.5% VaR violations
CBA returns
CaViaR
GARCH-t
10 CaViaR-RV
GARCH-RV-t
10
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 11: 1-period-ahead violations for p = 0.025 for CBA returns from several models
• Table shows the VaR 1% forecasting summary for all the models
Model A G GJR EG RM G-RV G-Ra Re-G-N-RV Re-G-N-Ra HS-T HS-100

Violations (10) 26 23 21 25 22 28 22 24 17 13 23
α̂ 0.026 0.023 0.021 0.025 0.022 0.028 0.022 0.024 0.017 0.013 0.023
α̂
α
2.60 2.30 2.10 2.50 2.20 2.80 2.20 2.40 1.70 1.30 2.30
p-valU C 0.000 0.000 0.005 0.000 0.000 0.000 0.000 0.000 0.026 0.340 0.000
p-valind 0.705 0.014 0.459 0.654 0.011 0.007 0.505 0.002 0.031 0.009 0.014
p-valDQ 0.000 0.000 0.008 0.001 0.000 0.000 0.006 0.000 0.000 0.000 0.000
Loss 52.00 53.28 51.52 51.36 56.95 53.86 50.43 56.10 50.03 77.32 68.28
Model A-t G-t GJR-t EG-t CAV CAV-RV CAV-Ra G-RV-t G-Ra-t Re-G-t-RV Re-G-t-Ra
Violations (10) 18 20 19 18 16 19 16 19 16 19 13
α̂ 0.018 0.020 0.019 0.018 0.016 0.019 0.016 0.019 0.016 0.019 0.013
α̂
α
1.80 2.00 1.90 1.80 1.60 1.90 1.60 1.90 1.60 1.90 1.30
p-valU C 0.011 0.002 0.004 0.011 0.057 0.004 0.057 0.004 0.057 0.004 0.3404
p-valind 0.416 0.413 0.370 0.329 0.253 0.004 0.023 0.370 0.253 0.049 0.157
p-valDQ 0.226 0.015 0.016 0.141 0.251 0.000 0.000 0.042 0.196 0.000 0.214
Loss 48.98 52.24 50.43 49.57 48.98 55.74 49.91 51.71 49.59 53.49 48.30
• For 1% VaR forecasting, the HS-T and Re-GARCH-t-Ra models have their VRates
closest to α = 0.01, with α̂ = 0.013 from 13 violations.
• Only the HS-T, Re-GARCH-t-Ra, CaViaR, CaV-Ra and GARCH-Ra-t did not
fail the UC test.
• On the other hand, all other models have too many violations, nearly double that
expected, and fail the UC test with violation rates significantly above 0.01.
• The GARCH-type models with Student-t errors do better than those with Gaus-
sian errors, all having fewer violations; however most still fail the UC test with
too many violations.
• Many models again fail the Ind and/or DQ tests, including all Gaussian error
models, both HS methods, GARCH-t and both CaViaR-X models.
• The only models which survive all 3 tests are: CaViaR, GARCH-Ra-t and Re-G-
t-Ra.
• Once again it is surprising that the highly accurate volatility forecasts from the
GARCH-X models did not translate into accurate 1% VaR forecasts; except for
GARCH-Ra-t.
• Of these three surviving models, the Realized GARCH-t-Ra has the lowest ob-
served quantile loss for its 1% VaR forecasts.
• These models appear to be much, much better at generating accurate VaR 1%
forecasts, with violations that are not significantly correlated over time or related
to the VaR forecast level, for CBA.
• These three models also rank as the top 3 1% VaR forecast models by minimum
quantile loss measure; i.e. CaViaR, GARCH-Ra-t and Re-G-t-Ra are the 3 closest
forecast series to the true VaR 1% series. Re-GARCH-t-Ra is the closest and most
accurate.
• The model that is not rejected by any test and has lowest quantile loss and
violation rate closest to 0.01 is the Re-GARCH-t-Ra. This is the best performing.
most accurate VaR 1% forecast model for CBA.
• This model is very closely followed by the CaViaR and GARCH-Ra-t models,
though these both have at least a couple more violations than the 13 by the
Re-GARCH-t-Ra.
• The Intra-day range has again performed very well at allowing accurate VaR 1%
forecasts, compared to the RV (which is not in the top 5 models!).
• The CaViaR model formulation, without the realized measures, seems the next
most optimal for 1% VaR forecasting for CBA.
• Violations for p = 0.01 are shown in Figure 12
1% VaR violations
CBA returns
CaViaR
GARCH-t
10 CaViaR-Ra
GARCH-Ra-t
10
2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01
Figure 12: 1-period-ahead violations for p = 0.01 for CBA returns from several models
Example: Tail risk forecasting 1-step-ahead: ES

Table 7: The 1-step-ahead forecast ES summary for all models for CBA, last 1000 days, p = 0.025.
Model A G GJR EG RM G-RV G-Ra Re-G-N-RV Re-G-N-Ra

ES Violations (9-10) 26 23 21 22 22 27 22 24 17
Target α 0.0097 0.0097 0.0097 0.0097 0.0097 0.0097 0.0097 0.0097 0.0097
α̂
α
2.68 2.37 2.17 2.27 2.27 2.78 2.27 2.47 1.75
p-valU C 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.019
p-valind 0.705 0.014 0.459 0.505 0.011 0.005 0.505 0.002 0.031
p-valDQ 0.000 0.000 0.005 0.006 0.000 0.000 0.004 0.000 0.000
Q Loss 50.89 52.12 50.45 50.22 55.78 52.76 49.37 54.99 48.97
Model A-t G-t GJR-t EG-t G-RV-t G-Ra-t Re-G-t-RV Re-G-t-Ra HS-T HS-100
ES Violations (9-10) 16 18 17 17 18 15 17 12 13 20
Target α 0.0088 0.0090 0.0090 0.0090 0.0089 0.0090 0.0090 0.0089 0.0090 0.0090
α̂
α
1.83 2.01 1.89 1.90 2.01 1.67 1.90 1.34 1.45 2.23
p-valU C 0.014 0.002 0.007 0.007 0.002 0.044 0.007 0.301 0.176 0.000
p-valind 0.4712 0.329 0.290 0.290 0.329 0.218 0.031 0.589 0.009 0.061
p-valDQ 0.348 0.029 0.021 0.043 0.017 0.123 0.000 0.922 0.000 0.000
Q Loss 44.11 47.81 46.54 45.49 47.80 45.91 49.41 44.62 72.36 62.77
• For ES 1-step ahead forecasting at p = 0.025, we expect ESRates close to the range
(Student-t) 0.0088-0.0097 (Gaussian), which are the target rates in the table, i.e.
≈ 9 − 10 violations on average.
• The target rates for Student-t error models were formed by averaging the degrees
of freedom estimates over the forecast sample, then finding the corresponding
quantile that the 2.5% ES occurs at.
• The Gaussian error GARCH-type models using squared returns all have at least
double the target rate of ES violations, and are significantly higher than their
target ES VRate of 0.0097, all failing the UC test.
• The Student-t error GARCH-type models using squared returns, whilst having
fewer ES violations than their Gaussian error counterparts, still all have signifi-
cantly higher than their target rates for ES violations and fail the UC test.
• The GARCH-X-N and Re-GARCH-N models also all fail the UC test, with nearly
double, or more, the target number of violations. The GARCH-RV-t and Re-G-
t-RV models also have significantly too many ES violations.
• The only models to not fail the UC test are the Re-GARCH-t-Ra and HS-T mod-
els; the Re-GARCH-t-Ra has closest to the nominal ESRate with 12 violations.
• The only 2 models that have ESRates close to their targets are: Re-GARCH-t-Ra
and HS-T, δ̂α = 0.012 and 0.013 from 12 and 13 violations respectively.
• Most models again fail the Ind and/or DQ tests, having significantly correlated
violations or violations related to ES forecast level.
• The only model that passes all 3 tests is the Re-GARCH-t-Ra model.
• It thus also has the lowest quantile loss value, i.e. it is the most accurate 2.5% ES
forecaster for CBA with forecasts closest to the true ES 2.5% series, for models
that pass all tests.
• ARCH-t had the lowets quantile loss but failed the UC test.
• Table shows information on the ES 2.5% residuals and joint loss for VaR, ES 2.5%
forecasting for CBA.
• The 1st row shows the 2.5% VaR violation numbers, which is exactly the number
of 2.5% ES residuals summarized in the following rows of the table.
• The model with largest magnitude 2.5% ES residual mean is HS-T. The GJR-t
has the smallest magnitude 2.5% ES residual mean.

VaR viols (25) 37 33 36 35 30 47 36 43 33
Mean ξ -0.330 -0.400 -0.241 -0.329 -0.573 -0.325 -0.271 -0.433 -0.264
t-stat ξ -2.637 -2.793 -2.166 -2.444 -3.244 -2.627 -2.175 -3.007 -1.946
Mean ξ /s -0.270 -0.344 -0.258 -0.283 -0.498 -0.293 -0.228 -0.326 -0.205
t-stat ξ /s -2.496 -2.713 -2.434 -2.434 -3.236 -2.557 -2.069 -2.635 -1.867
p-val 0.017 0.011 0.020 0.020 0.003 0.014 0.046 0.012 0.071
Joint loss 2.419 2.439 2.423 2.408 2.463 2.458 2.365 2.447 2.347
RMSE ξ 1.195 1.315 1.222 1.229 1.407 1.223 1.275 1.296 1.324
MAD ξ 0.637 0.721 0.677 0.664 0.864 0.636 0.649 0.701 0.715
VaR viols (25) 34 30 36 31 47 36 45 34 27 35
Mean ξ -0.210 -0.375 -0.147 -0.312 -0.191 -0.167 -0.286 -0.141 -0.897 -0.612
t-stat ξ -1.099 -1.638 -0.747 -1.482 -1.127 -0.794 -1.676 -0.660 -2.025 -2.382
Mean ξ /s -0.169 -0.365 -0.197 -0.301 -0.178 -0.178 -0.217 -0.158 -0.657 -0.455
t-stat ξ /s -0.945 -1.878 -1.189 -1.664 -1.163 -0.991 -1.378 -0.786 -2.022 2.181
p-val 0.351 0.0704 0.242 0.106 0.250 0.328 0.175 0.437 0.053 0.036
Joint loss 2.369 2.415 2.400 2.389 2.414 2.348 2.426 2.327 2.696 2.608
RMSE ξ 1.117 1.288 1.173 1.194 1.167 1.258 1.168 1.232 2.430 1.619
MAD ξ 0.568 0.719 0.695 0.628 0.661 0.701 0.649 0.695 1.758 1.095
• RM has the largest magnitude 2.5% ES standardised residual mean and t-statistic;
ARCH-t has the smallest magnitude standardised residual mean, whilst Re-G-t-
Ra has the smallest magnitude associated t-statistic and highest p-value.

• The t-test on the standardised 2.5% ES residuals finds that the ES forecast residual
means are significantly different to 0 for all GARCH and GARCH-X models with
Gaussian errors, plus the Re-G-N-RV models: we reject all of those forecast models
as being biased for α = 0.025 ES forecasting.
• However, we cannot reject the ARCH/GARCH(-X) models with Student-t errors,
or the Realized GARCH-t or the HS-T models as generating unbiased ES 2.5%
forecasts with mean 0.
• Figure 13 shows the forecast ES residuals for some models for their ES 2.5%
forecasts.
• In terms of joint 2.5% VaR, ES forecasting the Re-GARCH-t-Ra, and ARCH-t
models have the lowest joint loss values. However the ARCH-t is rejected by UC
and mean residual tests.
• Thus, the Re-GARCH-t-Ra model is the most accurate 2.5% joint VaR and ES
forecast model, with minimum joint loss.
2.5% ES residuals
ARCH G-t
2 ARCH-t G-RV-t
EG-t G-Ra-t
RM
6
0 10 20 30 40
Figure 13: Forecast residuals for ES (p = 0.025): ξt , for several models.

• The ARCH-t has easily the lowest ES residual RMSE and MAD for the ES resid-
uals, though the GJR-t and Re-GARCH-t-RV are not too far behind.
• The 2 models with highest joint loss values, as well as highest RMSE and MAD
values, are HS-T and HS-100.
• At p = 0.025, the Realized GARCH-t-Ra model is the most accurate, unbiased
forecaster of 1-day 2.5% ES levels and jointly the most accurate 2.5% VaR and
ES forecast model.
• Table shows the 1% ES forecast summary for each model

• For ES 1-step ahead forecasting at p = 0.01, we expect ESRates close to the range
(Student-t) 0.00355-0.00385 (Gaussian), which are the target rates in the table,
i.e. ≈ 3 − 4 violations on average.
• The target rates for Student-t error models were formed by averaging the degrees
of freedom estimates over the forecast sample, then finding the corresponding
quantile that the 1% ES occurs at.

ES Violations (3-4) 14 16 16 16 16 16 13 16 11
Target α 0.0038 0.0038 0.0038 0.0038 0.0038 0.0038 0.0038 0.0038 0.0038
α̂
α
3.639 4.159 4.159 4.159 4.159 4.159 3.379 4.159 2.859
p-valU C 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
p-valind 0.528 0.253 0.253 0.253 0.253 0.253 0.558 0.023 0.621
p-valDQ 0.000 0.000 0.000 0.000 0.000 0.000 0.003 0.000 0.051
Q Loss 26.674 28.211 26.831 26.484 29.861 30.173 27.201 31.037 26.161
ES Violations (3-4) 5 9 7 7 11 7 13 6 10 13
Target α 0.0035 0.0035 0.0036 0.0036 0.0035 0.0036 0.0036 0.0035 0.0036 0.0036
α̂
α
1.442 2.544 1.970 1.973 3.108 1.969 3.664 1.699 2.818 3.660
p-valU C 0.410 0.004 0.067 0.066 0.001 0.067 0.000 0.188 0.001 0.000
p-valind 0.823 0.686 0.753 0.753 0.106 0.753 0.009 0.788 0.085 0.009
p-valDQ 0.923 0.233 0.80 0.622 0.000 0.894 0.000 0.899 0.000 0.000
Q Loss 21.508 23.950 23.091 22.529 24.194 24.030 25.306 23.242 40.835 33.512
• The Gaussian error GARCH-type models using squared returns all have at least
triple (or more) the target rate of ES violations, and are significantly higher than
their target ES VRate of 0.0038, all failing the UC test.
• The Student-t error GARCH-type models using squared returns, have far fewer
ES violations (from 5-9) than their Gaussian error counterparts, and all except
the GARCH-t (9) have their 1% ES VRates not significantly different to their
target rates, so they pass the UC test.
• The exception is the GARCH-t model, which together with the GARCH-X models,
Re-G-RV models, Re-G-N-Ra, HS-100 and HS-T models, also fail the UC test with
significantly too many 1% ES violations.
• The models that have ES VRates closest to their target are: ARCH-t and Re-G-
t-Ra, with α̂ = 0.005 and 0.006, from 5 and 6 1% ES violations.
• The GJR-t, EG-t and GARCH-Ra-t also pass the UC test, though they have 7
1% ES violations which is 97% too many.
• All models with Gaussian errors fail the Ind and/or DQ tests, having significantly
correlated violations or violations related to ES forecast level.
• Most Student-t error models pass both the DQ and Ind tests, except the G-RV-t
and Re-G-t-RV models.
• The only models that pass all tests are: ARCH-t, GJR-t, EGARCH-t, GARCH-
Ra-t and Re-GARCH-t-Ra.
• Of these, the ARCH-t has the lowest quantile loss value, i.e. it is the most accurate
1% ES forecaster for CBA with forecasts closest to the true ES 1% series.
• The GJR-t, EGARCH-t, GARCH-Ra-t and Re-GARCH-t-Ra models are close
behind and these 5 models are the only models with quantile loss less than 24.
• Table 10 shows more measures for the 1% ES forecast for CBA.
• The 1st row shows the 1% VaR violation numbers, which is exactly the number
of 1% ES residuals summarized in the following rows of the table.
• The model with largest magnitude 1% ES residual mean is again HS-T. The
ARCH-t has the smallest magnitude 1% ES residual mean and associated t-
statistic; as well as the standardised versions of these.
• The t-test on the standardised 1% ES residuals finds that the ES forecast residual
means are significantly different to 0 for the RM, GARCH-N-RV and Re-GARCH-

VaR viols (10) 26 23 21 25 22 28 22 24 17
Mean ξ -0.431 -0.476 -0.570 -0.351 -0.649 -0.510 -0.511 -0.670 -0.655
t-stat ξ -1.876 -1.703 -2.043 -1.395 -2.453 -2.071 -1.750 -2.451 -1.795
Mean ξ /s -0.385 -0.494 -0.516 -0.355 -0.583 -0.472 -0.452 -0.592 -0.609
t-stat ξ /s -1.791 -2.048 -2.055 -1.657 -2.667 -2.072 -1.713 -2.366 -1.756
p-val 0.085 0.052 0.053 0.110 0.014 0.048 0.101 0.027 0.098
Joint loss 2.779 2.816 2.765 2.740 2.870 2.845 2.708 2.839 2.671
RMSE ξ 1.227 1.396 1.373 1.282 1.376 1.378 1.433 1.472 1.601
MAD ξ 0.569 0.771 0.661 0.671 0.755 0.759 0.738 0.856 0.826
VaR viols (10) 18 20 19 18 19 16 19 13 13 23
Mean ξ -0.043 -0.117 -0.234 -0.099 -0.415 -0.375 -0.345 -0.498 -1.447 -0.534
t-stat ξ -0.137 -0.372 -0.795 -0.290 -1.290 -1.008 -0.984 -1.135 -2.512 -1.842
Mean ξ /s -0.056 -0.184 -0.183 -0.187 -0.406 -0.342 -0.437 -0.443 -1.067 -0.415
t-stat ξ /s -0.191 -0.722 -0.692 -0.684 -1.344 -1.025 -1.463 -1.005 -2.528 -1.742
p-val 0.851 0.479 0.498 0.502 0.195 0.321 0.160 0.334 0.026 0.095
Joint loss 2.585 2.689 2.649 2.624 2.685 2.614 2.708 2.581 3.136 3.039
RMSE ξ 1.285 1.377 1.271 1.417 1.424 1.489 1.528 1.601 2.465 1.460
MAD ξ 0.675 0.772 0.618 0.761 0.731 0.821 0.891 0.833 1.916 0.982
N-RV models and the HS-T model: we reject those forecast models as being biased
for α = 0.01 ES forecasting.
• In terms of joint 1% VaR, ES forecasting, for models that pass all 4 tests, the
Re-GARCH-t-Ra model has the lowest joint loss value. The Re-G-t-Ra model is
thus the most accurate 1% joint VaR and ES forecast model, with minimum joint
loss.
• The ARCH-t, GJR-t and EG-t are close behind and also highly accurate 1% joint
VaR and ES forecasters
• The ARCH-N has easily the lowest ES residual RMSE and MAD for the ES
residuals; however this model has too many violations.
• The 2 models with highest joint loss values, as well as highest RMSE and MAD
values, are again HS-T and HS-100.
• At α = 0.01, for models that pass all the tests, the Realized GARCH-t-Ra model
is the most accurate, unbiased forecaster of 1-day 1% ES levels and jointly the
most accurate 1% VaR and ES forecast model.
• However the Re-GARCH-N-Ra and GARCH-Ra-t models have also performed
strongly, with 2nd and 3rd lowest joint loss values.
• Figure 14 shows the forecast ES residuals for some models for their ES 1% fore-
casts.
• The Re-GARCH-Ra-t model is jointly the most accurate, unbiased 1% VaR and
ES forecast model at α = 0.01.
• At α = 0.01, the Re-GARCH-Ra-t model is also the most accurate 1% VaR
forecaster, with lowest quantile loss.
• At α = 0.025, of the models surviving all the 4 tests, the Re-GARCH-Ra-t is the
most accurate, unbiased forecaster of 1-day 2.5% ES levels, marginally ahead of
the ARCH-t model.
• The Re-GARCH-Ra-t model is jointly the most accurate 2.5% VaR and ES fore-
cast model at α = 0.025.
• At α = 0.025, the Re-GARCH-Ra-t model is rejected by the DQ test. The
GARCH-Ra-t is the most accurate 2.5% VaR forecaster, with lowest quantile loss.
• The GARCH-Ra-t model was also highly competitive at 2.5% ES and joint VaR
1% ES residuals
ARCH G-t
2 ARCH-t G-RV-t
EG-t G-Ra-t
RM
1
6
0 5 10 15 20 25
Figure 14: Forecast residuals for ES (p = 0.01): ξt , for several models.

and ES forecasting, as well as 1% ES and joint 1% VaR and ES forecasting.

• In all cases, all models employing the RV were rejected, by at least 1 test, for tail
forecasting for CBA and were not competitive in their loss function values.
• In the Python code for this lecture are the same results for WES.
• Very similar outcomes are found, with either the Re-GARCH-Ra-t model or
GARCH-Ra-t model typically being the most accurate 2.5% and/or 1% VaR and
ES forecast model.
• In summary, using realized measures, based on intra-day data, as inputs to para-

metric volatility models and semi-parametric quantile models significantly im-
proves all aspects of forecast accuracy.
• Especially for: volatility forecasting and tail risk forecasting
• We found for CBA that, the intra-day range, Ra, was more beneficial than the
realized volatility (RV) or squared shocks, for 1-day-ahead volatility forecasting,
via GARCH-X and/or Realized GARCH-t-Ra models.
• Further, the intra-day range (via Proxy 2) was more beneficial for both VaR and
ES 1-day-ahead forecasting, via the Realized GARCH-t-Ra model for 1% VaR,
2.5% ES and 1% ES and via a GARCH-Ra-t model with Student-t errors for 2.5%
VaR forecasting.
• There is currently lots of current, on-going research on, e.g.:
• Which of the (hundreds of) realized measures (at which of hundreds of frequencies)
contains the most useful information to forecast risk of financial returns?
• Can a set of realized measures be combined in an optimal way (e.g. average, linear
combination), to improve forecasts of risk of financial returns? And which ones,
and how many?
• Are there more optimal model specifications, loss functions for estimation, to
employ realized measures, so as to improve forecasts of risk of financial returns?
Tail risk forecasting 10-steps-ahead

• In lectures 4 of module 4 we found that many of the standard GARCH models,
indeed almost all models we tried, were mostly rejected as accurate 10-day-ahead
VaR and ES forecast models.
• This is where the financial time series literature was at about a decade ago.
• Hundreds more volatility models, different error distributions, different types of
nonlinearity, etc were tried, yielding mostly only small gains in accuracy of tail
risk forecasts.
• Then, we tried using realized measures in Realized GARCH tyoe models, that
included a measurement equation. Here is what we found . . .
Example: Tail risk forecasting 10-step-ahead

• The Realized GARCH model allows h-step ahead forecasting of volatility and tail
risk.
• This is because the measurement equation:
log(Xt2) = ξ + ψ log(σt2) + ut
allows a distribution to be specified on ut
• And hence a conditional distribution for log(Xt2)| log(σt2) can be employed to
simulate future values Xt+h
• In exactly the same way h > 1 Monte Carlo simulation is done for GARCH
2
models. i.e. whenever a simulated value of σt+k is calculated, a value for ut+k can
2
be simulated and these can be combined to evaluate a single value of log(Xt+k )
• Usually ut ∼ N (0, τ 2) is employed.
Section (4e): Example: CBA

• I now forecast VaR and ES for the non-overlapping 10 day returns for CBA, after
20th Dec, 2007. This gives 353 non-overlapping 10-day returns to forecast.
• It allows an in-sample period of T = 2015 returns to estimate the formal models.
• I use the ARCH(5), GARCH, GJR, EGARCH and Realized-GARCH models, all
with both Gaussian and Student-t errors, plus the RiskMetrics model (both by
simulation and Gaussian assumption), for daily data and generate 10 day ahead
forecasts of rt[10].
• I estimate the models using daily data previous to the 10 day period being
forecast, re-estimating all models for each new 10-day forecast.
• I use MC sample size 50000.

• Figure 15 shows the σ[10], VaR10 and ES10 forecasts at p = 0.025 for the GARCH-t
and Re-GARCH-t-RV models (all using MC simulation).
20
10
10
20
CBA 10-day returns
30 Vol G-t
VaR G-t
ES G-t
40 Vol Re-G-t
VaR Re-G-t-RV
ES Re-G-t-RV
2008 2010 2012 2014 2016 2018 2020 2022
Figure 15: 10 day non-overlapping returns for CBA plus forecasts of σ[ 10], VaR10 and ES10 at p = 0.025 for the GARCH-t and Re-
GARCH-t-RV models.
• The two VaR and ES series are fairly close to each other, though often the G-t
model gives slightly more extreme forecasts.
• Except for during the high volatility period end of 2008, where Re-G-t-RV gives
the most extreme forecasts.
• Figure 16 shows the VaR10 and ES10 forecasts at p = 0.025 for the RM Gaussian
and HS models.
• The table shows the 10-step-ahead VaR 2.5% forecasting summary for all the
models
• At p = 0.025, the 10-step-ahead forecasts for VaR are most accurate in VRate for
the GJR-N, EG-N and GJR-t methods: these models also pass all the UC DQ
and Ind tests.
20
10
10
CBA 10-day returns

20 VaR HS100
ES HS100
VaR HST
30 ES HST
VaR RM
ES RM
40 VaR RM N
ES RM N
2008 2010 2012 2014 2016 2018 2020 2022
Figure 16: 10 day non-overlapping returns for CBA plus forecasts of VaR10 and ES10 at p = 0.025 for the informal, adhoc methods.
• The 3 best models by VRate are the GJR-N, EG-N and GJR-t. Of these, the
GJR-N has the lowest quantile loss value, whilst the HS-100 has the worst/highest
Model A G GJR EG RM Re-G-RV Re-G-Ra HS-T

Violations (8-9) 14 18 11 11 12 16 16 14
α̂ 0.040 0.051 0.031 0.031 0.034 0.045 0.045 0.040
α̂
α
1.586 2.039 1.246 1.246 1.359 1.813 1.813 1.586
p-valU C 0.077 0.002 0.458 0.458 0.279 0.014 0.014 0.077
p-valind 0.577 0.296 0.341 0.341 0.057 0.189 0.189 0.036
p-valDQ 0.034 0.013 0.703 0.637 0.047 0.019 0.012 0.000
Loss 137.523 138.590 132.654 135.294 136.505 143.482 149.344 154.296
Model A-t G-t GJR-t EG-t Re-G-RV-t Re-G-Ra-t RM N iid N HS-100
Violations (25) 13 16 11 12 18 17 14 14 13
α̂ 0.037 0.045 0.031 0.034 0.051 0.048 0.040 0.040 0.037
α̂
α
1.473 1.813 1.246 1.359 2.039 1.926 1.586 1.586 1.473
p-valU C 0.155 0.014 0.458 0.279 0.002 0.005 0.077 0.077 0.154
p-valind 0.492 0.189 0.340 0.057 0.296 0.239 0.109 0.577 0.451
p-valDQ 0.032 0.015 0.633 0.032 0.003 0.008 0.034 0.065 0.126
Loss 137.141 141.226 137.916 137.460 145.491 145.988 140.739 153.104 164.217
quantile loss.
• The UC test rejects the Re-GARCH-RV and Re-GARCH-Ra models, both with
N and t errors, as having significantly too many 2.5% VaR violations.
• The incorrect RM N model (14) has 2 more violations than the simulation-based
RM model (12). Both are not rejected by the UC test.
• The Independence test only rejects the HS-T method; whilst the DQ test rejects all
models except the GJR-N, EG-N, GJR-t models and iid N and HS-100 methods.
• For models not rejected by any test, the quantile loss function values favour the
GJR-N model; same as in lecture 4 of module 4 (week 12).
• The iid N, HS-100 and HS-T models rank in the 3 last places by the loss function.
• For VaR 10-step forecasts at p = 0.025, the GJR-N model is the best performing
model overall, followed closely by the EGARCH-N model.
• Figure 18 shows 2.5% VaR violations for the ARCH-N, GJR-GARCH-N, HS-T
and RM methods.
• Clearly the HS-T has correlated and clustered violations, whilst the RM has too
many violations.
20
10
10
TLS returns: forecast period

20 ARCH 2.5% VaR violations
GARCH-t
Re-G-t
HS-T
2008 2010 2012 2014 2016 2018 2020 2022
Figure 17: 10 day returns for CBA plus 2.5% VaR10 violations for some models.
• The table shows the 10-step-ahead VaR 1% forecasting summary for all the models
Model A G GJR EG RM Re-G-RV Re-G-Ra HS-T

Violations (3-4) 6 10 9 9 11 12 13 6
α̂ 0.017 0.028 0.025 0.025 0.031 0.034 0.037 0.017
α̂
α
1.699 2.832 2.549 2.549 3.116 3.399 3.682 1.700
p-valU C 0.186 0.001 0.003 0.003 0.000 0.000 0.000 0.186
p-valind 0.081 0.274 0.492 0.215 0.039 0.057 0.080 0.081
p-valDQ 0.007 0.002 0.027 0.004 0.000 0.000 0.000 0.000
Loss 79.601 83.536 75.239 78.132 76.966 85.561 93.256 102.138
Model A-t G-t GJR-t EG-t Re-G-RV-t Re-G-Ra-t RM N iid N HS-100
Violations (3-4) 5 10 10 9 13 11 11 7 12
α̂ 0.014 0.028 0.028 0.025 0.036 0.031 0.031 0.020 0.034
α̂
α
1.416 2.833 2.833 2.550 3.682 3.116 3.116 1.983 3.399
p-valU C 0.432 0.001 0.001 0.003 0.000 0.001 0.000 0.0634 0.000
p-valind 0.492 0.189 0.340 0.057 0.296 0.239 0.109 0.577 0.451
p-valDQ 0.003 0.001 0.001 0.004 0.000 0.000 0.000 0.000 0.000
Loss 78.882 85.119 80.245 80.014 86.477 88.825 83.712 101.014 103.315
• At p = 0.01, the 10-step-ahead forecasts for VaR are most accurate in VRate for
the ARCH-t model, with 5 violations and V Rate = 0.013; same as last week.
• All other models are rejected by the UC test, with 8-13 violations; except the
ARCH-N and HS-100 models, with 6 and 7 violations respectively.
• The 3 best models by VRate are the ARCH-t, ARCH-N and HS-100. Of these,
the ARCH-t has the lowest quantile loss value, whilst the HS-T and HS-100 have
the worst/highest quantile loss.
• The models with lowest quantile loss are the GJR-N, RM (simulation) and EG-N;
but all are rejected by the UC and DQ tests.
• In fact, all models are rejected by the DQ test
• The incorrect RM N model (11) hasthe same violations as the simulation-based

RM model (11). Both are rejected by the UC test.
• The iid N, HS-100 and HS-T models rank in the 3 last places by the loss function.
• For VaR 10-step forecasts at p = 0.01, the ARCH-t model is the best performing
model overall, but is still rejected by the DQ test.
• Figure 18 shows 1% VaR violations for the ARCH-N, GARCH-t, Re-GARCH-t

and HS-T methods.
• Clearly the HS-T has correlated and clustered violations, whilst the Re-GARCH-t
has too many violations.
• For 10-day ahead ES forecasting at the 2.5% risk level, the best models by joint
loss were: ARCH-t, RM, GJR-N. Only the ARCH-t had close to the expected 3-4
violations with 5.
• For 10-day ahead ES forecasting at the 1% risk level, the best models by joint loss
were: ARCH-t, RM, GJR-N (again). Only the ARCH-t had close to the expected
1 violation with 3.
20 TLS returns: forecast period

ARCH 1% VaR violations
GARCH-t
Re-G-t
HS-T
10
10
20
2008 2010 2012 2014 2016 2018 2020 2022
Figure 18: 10 day returns for CBA plus 2.5% VaR10 violations for some models.
• The Realized GARCH models, though very good at 1 day ahead tail risk forecats-
ing, have not improved on the poor 10-day ahead tail risk forecasting accuracy of
the other models, from last week.
• There are versions of Re-GARCH models with leverage effects and asymmetric
volatility. Given that GJR and EG models did better for 10-day forecasting,
compared to 1 day forecasting, the asymmetric Re-GARCH models would be
worth a try.

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QBUS6830 (S2, 2022); Module 4; Week 13 1

Module 4: Forecasting and Risk Management

Models incorporating and modelling realized intra-day measures

• We can do this with semi-parametric CaViaR models too.

• Further, we can ”complete” the GARCH-X model by modelling the contempora-

• We can add a realized measure directly into the quantile equation.

square root is applied.

• The only parameter restriction is |β1| < 1

CaViaR-X models: example

• The estimates for the standard CaViaR quantile equations are:

• The estimated CaViaR-X quantile equations are:

3. The β1 values, estimating the effect of today’s quantile Qt on tomorrow’s quan-

return, compared to less extreme quantiles.

• Indeed the GARCH-t, GARCH-RV-t and GARCH-Ra-t models have quantile

CBA: In-sample 1% VaR estimates

2002 2004 2006 2008 2010 2012 2014 2016 2018

Figure 1: In-sample conditional 1% VaR estimates: CaViaR(-X).

Realized GARCH models

• Hansen et al (2012) proposed to add a 3rd equation, a so-called measurement

• The simplest measurement equation they proposed is:

• An unbiased realized measure would have ξ = 0, ψ = 1, i.e. E(Xt2) = E(σt2)

• This Realized GARCH model is then:

• It is also common, and recommend by Hansen et al (2012), to model the logarithms

• This Realized Exponential GARCH model is then:

• This is the specification I will illustrate today.

• Parameter restrictions for stationarity are are: |α1ψ + β1| < 1

• this is because log(Xt−1

• However, since exp E(log Xt ) ̸= E exp(log Xt ) = E(Xt2), ξ = 0, ψ = 1 in

the Re-Exp-GARCH model does not indicate an unbiased realized measure.

• In fact, we know that exp E(log Xt ) < E exp(log Xt ) , so ξ = 0, ψ = 1 in the

Re-Exp-GARCH model would indicate a biased realized measure.

• Estimation is done by maximum likelihood, where:

Realized GARCH models: example

• The estimated GARCH-t variance equation is:

• The estimated GARCH-X-t variance equation is

• The estimated Realized GARCH-t-N variance equation is

Model α1 , β2 β1 Persistence ν ξ ψ τu2

• In-sample 1% VaR estimated series for GARCH-t, GARCH-X-t and Realized

• The more extreme GARCH-RV-t volatility estimates in 2004-2005 give rise to

• The Re-GARCH-N-RV, Re-GARCH-N-Ra, Re-GARCH-t-RV, Re-GARCH-t-Ra

In-sample volatility estimates

Figure 2: In-sample conditional volatility estimates: Gaussian models.

CBA: In-sample volatility estimates, Student-t

Figure 3: In-sample conditional volatility estimates: Student-t models.

• The Re-GARCH-N-RV, Re-GARCH-N-Ra, Re-GARCH-t-RV, Re-GARCH-t-Ra

CBA: In-sample 1% VaR estimates, Student-t

Figure 4: In-sample conditional 1% VaR estimates: Student-t models.

357.6, 345.6 and 356.7 respectively.

Example: 1 step-ahead volatility forecasting

• Also, the RM, HS-100 and HS-T methods were employed.

RV-N, GARCH-Ra-N, Re-G-N-RV and Re-G-N-Ra volatility models for CBA.

Model Proxy 1 Proxy 2 Proxy 3 Proxy 4 Proxy 5

• The GARCH-RV-N or GARCH-RV-t is always the most accurate volatility fore-

Model Proxy 1 Proxy 2 Proxy 3 Proxy 4 Proxy 5

• The HS-T is always the least accurate volatility forecasting model.

Measure RMSE MAD

• There is again quite some consistency in the ranking of models.

• The 16 formal, parametric GARCH(-X)-type and Re-GARCH models always fin-

• The Re-G-t-RV, Re-G-N-Ra, GARCH-Ra-t, EGARCH-N and GJR-N are typi-

Tail risk forecasting 1-step-ahead

Example: Tail risk forecasting 1-step-ahead

2.5% VaR Forecasts of Some Models

2018-07 2019-01 2019-07 2020-01 2020-07 2021-01 2021-07 2022-01