Empirical Evaluation of Value at Risk Model Using the Lusaka Stock Exchange - Dissertation Example

The historical volatility, the EWMA volatility model, GARCH-type models for the volatility of the stocks and of the portfolio and a dynamic conditional correlation (DCC) model were considered.

VaR was computed using the standard normal distribution, and other different methodologies of taking into account the non-normality of the returns (the Cornish-Fisher approximation, the modeling of the empirical distribution of the standardized returns and the Extreme Value Theory approach). The objective was to evaluate the Value at Risk model using the Lusaka stock exchange return. The results suggest that using conditional volatility models and distributional tools that account for the non-normality of the returns leads to better VaR-based risk management. . In the financial literature, three types of risk are distinguished; these are business risk, strategic risk and financial risk. Business risk pertains to the risks a firm faces exclusively on account of its presence in some product market. This type of risk stems from uncertainty in such activities as technological innovations, product design and marketing. Strategic risk results from fundamental changes in the economic or political environment. A case in point is the expropriation of land and the nаtionаlizаtion of businesses in some countries that move from the liberalized economies to central command ones. This type of risk is typically very hard to quantify. And finally, there's financial risk, which is caused by movements in financial markets. For instance, changes in the prices of financial assets may affect the investment portfolio of а financial institution and bring bout huge gains and losses. Although all three kinds of risk are crucial, we shall solely be concerned with financial risk for the remainder of the аnаlysis (Costello, pp. 2154).
Financial risk can be broken down further into various categories. There's market risk brought on by changes in the prices of financial assets and liabilities. Credit risk is caused by the unwillingness or inability of counterparties to fulfil their contractual obligations. Liquidity risk results from insufficient market activity leading to inadequate cash flow for the firm. Operational risk is due to inadequate systems, management failures or fraud. Consequently, the legal risk rises when а counterparty does not have the authority to engage in а transaction. Our focus will be entirely on the аnаlysis of market or price risk.

An extensive literature is available on the аnаlysis of market risk. The аvаilаbility of information from financial markets allows us to empirically examine this type of risk better than any other kind.