Looking forward to back testing

Carsten Wehn
01 May 2008

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To measure market risk, banks usually predict the distribution of the future (and therefore unknown) gains and losses G_t of a portfolio. Modelling gains and losses is achieved by taking into account all relevant information given by observed risk factor prices or returns, respectively. Thus, the relevant conditional univariate one-step-ahead predictive distribution can be denoted by F_t: = F_t(G_t/R_t-1, R_t-2, ... ), where R_t-1, R_t-2, ... describes (multivariate) past risk factor returns. Three main

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