Extreme Risk: Inconsistent risk measurements

I am using six different methods to forecast risk. For details see the technical page. sss

The six have all their own pros and cons:

Method Focus on time dependence Focus on tails
EWMAyesno
HSnoyes
MAnono
EVTnoyes
GARCHyespartially
t-GARCHyesyes
VIXyesno

The methods used to forecast risk on these pages sometimes deliver very different measurements. There is nothing special about this inconsistency, anybody forecasting risk will encounter that.

Does it matter that the riskometers are so inconsistent? In theory, it shouldn't. A good risk manager knows riskometers are imprecise. They know the strengths and weaknesses of each, treating them as a portfolio of methods, picking the best one for the problem at hand.

For example, EWMA is really simple, and nothing can go wrong when implementing it. It reacts quickly to changing information. However, just like an overeager teenager, it can respond way too strongly to new information. HS is opposite, calm, and stable. Nothing ruffles it, like a seasoned bureaucrat.

Which do you prefer? It depends. HS's conservativeness is an asset for day-to-day operations, but when a shock hits, you need a quick reaction, and that is when EWMA can be invaluable.

Then, there is the dark horse of EVT, short for extreme value theory, like the wise man who has nothing to say about day-to-day occurrences but tells us what we need to know about the extremes when everything goes wrong.

All the riskometers have their good sides, and a good risk manager will be guided by her intuition and experience. Seeing EWMA is $25 and GARCH $21, while HS is $64.7, tells her not only that short term risk has fallen quite a bit recently but is still relatively high by historical standards. Meanwhile, EVT says long-term risk has picked up because of Covid-19.

The risk manager knows each number tells a different part of the story, and by using all of them, she gets a much more complete story.

It is only we we have to pick one riskometer and stick with it, that we get seriously misled.


Extreme risk

Daily market risk forecasts and analysis
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