Backtesting value-at-risk accuracy: a simple new test

Christophe Hurlin, Sessi Tokpavi *

Abstract

ABSTRACT

This paper proposes a new test of value-at-risk (VAR) validation. Our test exploits the idea that the sequence of VAR violations (hit function) – taking value 1 – á if there is a violation, and –á otherwise – for a nominal coverage rate á verifies the properties of a martingale difference if the model used to quantify risk is adequate (Berkowitz et al., 2005). More precisely, we use the multivariate portmanteau statistic of Li and McLeod (1981), an extension to the multivariate framework of the test of Box and Pierce (1970), to jointly test the absence of autocorrelation in the vector of hit sequences for various coverage rates considered relevant for the management of extreme risks. We show that this shift to a multivariate dimension appreciably improves the power properties of the VAR validation test for reasonable sample sizes.