Forecasting day-ahead expected shortfall on the EUR/USD
exchange rate: The (I)relevance of implied volatility

J 2024

Forecasting day-ahead expected shortfall on the EUR/USD exchange rate: The (I)relevance of implied volatility

LYÓCSA, Štefan, Tomáš PLÍHAL and Tomáš VÝROST

Basic information

Original name

Forecasting day-ahead expected shortfall on the EUR/USD exchange rate: The (I)relevance of implied volatility

Authors

LYÓCSA, Štefan, Tomáš PLÍHAL and Tomáš VÝROST

Edition

International Journal of Forecasting, 2024, 0169-2070

Other information

Language

English

Type of outcome

Článek v odborném periodiku

Field of Study

50206 Finance

Confidentiality degree

není předmětem státního či obchodního tajemství

References:

URL

Impact factor

Impact factor: 7.900 in 2022

Organization unit

Faculty of Economics and Administration

DOI

http://dx.doi.org/10.1016/j.ijforecast.2023.11.003

UT WoS

001307795600001

Keywords in English

Finance; Expected shortfall; Implied volatility; Volatility models; Forecasting

Abstract

V originále

The existing literature provides mixed results on the usefulness of implied volatility for managing risky assets, while evidence for expected shortfall predictions is almost nonexistent. Given its forward-looking nature, implied volatility might be more valuable than backward-looking measures of realized price fluctuations. Conversely, the volatility risk premium embedded in implied volatility leads to overestimating the observed price variation. This paper explores the benefits of augmenting econometric models used in forecasting the expected shortfall, a risk measured endorsed in the Basel III Accord, with information on implied volatility obtained from EUR/USD option contracts. The day-ahead forecasts are obtained from several classes of econometric models: historical simulation, EGARCH, quantile regression-based HAR, joint VaR and ES model, and combination forecasts. We verify whether the resulting expected shortfall forecasts are well-specified and test the models’ accuracy. Our results provide evidence that the information provided by forward-looking implied volatility is more valuable than that in backward-looking realized measures. These results hold across multiple model specifications, are stable over time, hold under alternative loss functions, and are more pronounced during periods of higher market uncertainty when risk modeling matters most.

Links

GA22-27075S, research and development project

Name: Předpovídání tržního rizika: Role obchodní aktivity, pozornosti a sentimentu

Investor: Czech Science Foundation

Citovat

LYÓCSA, Štefan, Tomáš PLÍHAL and Tomáš VÝROST. Forecasting day-ahead expected shortfall on the EUR/USD exchange rate: The (I)relevance of implied volatility. International Journal of Forecasting. 2024, In Press, Corrected Proof. ISSN 0169-2070. Available from: https://dx.doi.org/10.1016/j.ijforecast.2023.11.003.

@article{2399700,
   author = {Lyócsa, Štefan and Plíhal, Tomáš and Výrost, Tomáš},
   article_number = {In Press, Corrected Proof},
   doi = {http://dx.doi.org/10.1016/j.ijforecast.2023.11.003},
   keywords = {Finance; Expected shortfall; Implied volatility; Volatility models; Forecasting},
   language = {eng},
   issn = {0169-2070},
   journal = {International Journal of Forecasting},
   title = {Forecasting day-ahead expected shortfall on the EUR/USD exchange rate: The (I)relevance of implied volatility},
   url = {https://www.sciencedirect.com/science/article/pii/S0169207023001115},
   year = {2024}
}

TY  - JOUR
ID  - 2399700
AU  - Lyócsa, Štefan - Plíhal, Tomáš - Výrost, Tomáš
PY  - 2024
TI  - Forecasting day-ahead expected shortfall on the EUR/USD exchange rate: The (I)relevance of implied volatility
JF  - International Journal of Forecasting
IS  - In Press, Corrected Proof
SN  - 01692070
KW  - Finance
KW  - Expected shortfall
KW  - Implied volatility
KW  - Volatility models
KW  - Forecasting
UR  - https://www.sciencedirect.com/science/article/pii/S0169207023001115
N2  - The existing literature provides mixed results on the usefulness of implied volatility for managing risky assets, while evidence for expected shortfall predictions is almost nonexistent. Given its forward-looking nature, implied volatility might be more valuable than backward-looking measures of realized price fluctuations. Conversely, the volatility risk premium embedded in implied volatility leads to overestimating the observed price variation. This paper explores the benefits of augmenting econometric models used in forecasting the expected shortfall, a risk measured endorsed in the Basel III Accord, with information on implied volatility obtained from EUR/USD option contracts. The day-ahead forecasts are obtained from several classes of econometric models: historical simulation, EGARCH, quantile regression-based HAR, joint VaR and ES model, and combination forecasts. We verify whether the resulting expected shortfall forecasts are well-specified and test the models’ accuracy. Our results provide evidence that the information provided by forward-looking implied volatility is more valuable than that in backward-looking realized measures. These results hold across multiple model specifications, are stable over time, hold under alternative loss functions, and are more pronounced during periods of higher market uncertainty when risk modeling matters most.
ER  -

LYÓCSA, Štefan, Tomáš PLÍHAL and Tomáš VÝROST. Forecasting day-ahead expected shortfall on the EUR/USD exchange rate: The (I)relevance of implied volatility. \textit{International Journal of Forecasting}. 2024, In Press, Corrected Proof. ISSN~0169-2070. Available from: https://dx.doi.org/10.1016/j.ijforecast.2023.11.003.

Detailed Information on Publication Record