Backtesting VaR under the COVID-19 sudden changes in volatility

Area of Science:

• Financial Economics
• Econometrics
• Pandemic Studies

Background:

• The COVID-19 pandemic introduced unprecedented volatility into global financial markets.
• Understanding shifts in stock return variance is crucial for financial risk management.

Purpose of the Study:

• To analyze the impact of the COVID-19 pandemic on the conditional variance of stock returns globally.
• To assess the effect on downside risk measures like Value-at-Risk.

Main Methods:

• Utilized Hansen's Skewed-t distribution with an extended EGARCH model.
• Employed time series data from major global stock market and sector indices.
• Controlled for sudden changes in volatility and analyzed Value-at-Risk.

Main Results:

• A significant upward shift in return distribution variance was observed post-pandemic announcement.
• The pandemic demonstrably altered stock market volatility dynamics.
• Downside risk measures were notably affected by the increased variance.

Conclusions:

• The pandemic caused a structural break in stock return variance.
• Accurate financial risk management requires accounting for this pandemic-induced volatility shift.
• Reliable Value-at-Risk estimations depend on models that capture these changes.