Which one to Use for Computing VaR?
Released on September 21, 2014, this whitepaper explores a critical decision for Risk teams: whether to use Historical or Implied Volatility for computing VaR. It compares the performance of both volatilities in calculating Value-at-Risk (VaR) for two commodities – Coffee and Sugar – with back-testing results using Historical Volatility (EWMA with lambda = 0.94) and Implied Volatility (from ATM near-month options).
The paper aims to answer the age-old question faced by Risk teams: Which volatility measure gives a more accurate prediction of VaR? It examines the reliability of Historical and Implied Volatility through several key performance metrics, such as outliers, P&L traceability, and how each volatility method behaves under varying market conditions.
This whitepaper provides valuable insights, including:
This paper offers a comprehensive comparison that will help risk practitioners determine the most effective volatility model to use for risk estimation, enhancing the precision of their VaR calculations.
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