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Finance and Economics Discussion Series
The Finance and Economics Discussion Series logo links to FEDS home page Evaluating the Forecasts of Risk Models
Jeremy Berkowitz

Abstract: The forecast evaluation literature has traditionally focused on methods for assessing point-forecasts. However, in the context of risk models, interest centers on more than just a single point of the forecast distribution. For example, value-at-risk (VaR) models, which are currently in extremely wide, use form interval forecasts. Many other important financial calculations also involve estimates not summarized by a point-forecast. Although some techniques are currently available for assessing interval and density forecasts, none are suitable for sample sizes typically available. This paper suggests a new approach to evaluating such forecasts. It requires evaluation of the entire forecast distribution, rather than a value-at-risk quantity. The information content of forecast distributions combined with ex post loss realizations is enough to construct a powerful test even with sample sizes as small as 100.

Keywords: Forecast, evaluation, risk, VaR

Full paper (133 KB PDF) | Full paper (1112 KB Postscript)

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Last update: March 25, 1999