"Value-at-Risk and Expected Shortfall Estimations Based On GARCH-Type Models: Evidence From Energy Commodities," by Samir Mabrouk

THE JOURNAL OF ENERGY
AND DEVELOPMENT
Samir Mabrouk,
Value-at-Risk and Expected Shortfall Estimations
Based on GARCH-Type Models:
Evidence from Energy Commodities,

Volume 35, Number 2
Copyright 2011
www.iceed.org
VALUE-AT-RISK AND EXPECTED SHORTFALL
ESTIMATIONS BASED ON GARCH-TYPE MODELS:
EVIDENCE FROM ENERGY COMMODITIES
Samir Mabrouk*
Introduction
O
il has become the principal source of energy for the majority of the world. But
along with its dominance, this commodity has experienced significant price
volatility since the 1970s, and this volatilty requires a risk measurement. Value-at-
risk (VaR) is considered the most well-known tool of risk quantification. In fact,
VaR provides the potential loss (expressed in monetary units) that a portfolio can
generate with a probability level and over a defined holding period. Therefore,
VaR remains a very attractive risk measure for managers since it can assist them in
decision making. The majority of empirical analysis based on VaR models has
focused on financial market risk and foreign exchange risk. Unfortunately, few
empirical studies dealing with quantifying commodity market risk have been
developed. P. Giot and S. Laurent consider daily data for a collection of com-
modities including Brent crude oil and West Texas Intermediate (WTI) crude oil
to evaluate the performance of one-day-ahead VaR for both long- and short-
trading positions; they have assessed RiskMetrics, skewed Student-t APARCH
(asymmetric power autoregressive conditional heteroskedasticity), and skewed
*Samir Mabrouk, who holds a doctoral degree from the Faculty of Economic Sciences and
Management of Tunis, teaches finance in the Department of Finance, the High School of Business,
Manouba University, Tunisia, and is a member of the International Finance Group in that country.
His research has focused on value-at-risk estimations when financial and commodity market
volatilities are governed by long-range memory processes. The authors papers have been published
in the International Journal of Financial Services Management, Energy Policy, and International
Journal of Monetary Economics and Finance.
The Journal of Energy and Development, Vol. 35, Nos. 1 and 2
Copyright 2011 by the International Research Center for Energy and Economic Development
(ICEED). All rights reserved.
279
Student-t ARCH (autoregressive conditional heteroskedasticity) models.
1
Their
results confirm that the skewed Student-t APARCH model performs better in all
cases. P. Sadorsky has focused on daily closing futures price returns on West
Texas Intermediate crude oil, heating oil, unleaded gasoline, and natural gas and
computed parametric and non-parametric VaR models; the results of her paper
suggest that the second model performs the best, a finding consistent with C.
Brooks and G. Persand.
2
D. Cabedo and I. Moya used a daily spot Brent oil prices
for the period 1992 to 1999, where the last year was considered for the out-of-
sample forecasting, and computed the VaR via three different methodologies,
namely, the historical simulation standard approach, the historical simulation with
autoregressive moving average forecasts (HSAF) approach, and the variance
covariance method based on autoregressive conditional heteroskedasticity models
forecasts.
3
The results affirm that the HSAF approach performs better than the
others; it provides a reliable VaR measurement that is suitable to model the
continuous oil price movements well and provides efficient risk quantification. M.
Sadeghi and S. Shavvalpour used weekly prices of the Organization of Petroleum
Exporting Countries (OPEC) for a period of seven years (1997-2003), where the
last year was used for the out-of-sample testing aim; they computed VaR based on
two different methodologies: the historical simulation ARMA forecasting (HSAF)
and the variance-covariance approach.
4
Their results show that whatever the
specific methodology considered used for computation, VaR is a trustworthy
measure of oil price risk. J.-C. Hung et al. used daily prices for five energy
commodities (WTI crude oil, Brent crude oil, heating oil, propane, and New York
Harbor conventional gasoline regular) to assess the one-day-ahead VaR using
three GARCH-type models: GARCH-N, GARCH-t, and GARCH-HT. Their
findings show that the estimated VaR generated by the GARCH-HT models is the
best since the distribution of these energy asset returns are heavy-tailed.
5
Y. Fan
and J. Jiao examined daily spot WTI and Brent crude oil prices for the period
1987-2006 to compute the VaR; their estimation was based on GARCH-type
models under a generalized error distribution (GED), and the results indicated that
the GED-GARCH-based VaR approach appeared more efficient than historical
simulation with ARMA forecasts (HSAF).
6
The contribution of this paper to the existing body of literature is threefold.
First, the majority of empirical studies dealing with volatility stylized facts, such
as asymmetry, fat-tails, and long memory, have not been developed in the context
of energy markets data with a few exceptions, for example, C. Aloui and S.
Mabrouk.
7
In this paper, we have studied jointly asymmetry, tail fatness, and
persistence in the volatility of four daily energy assets return innovations. For all
samples, the skewed Student FIAPARCH model has provided the best results
when compared to the other models. The FIAPARCH model is able to take into
account both asymmetry and long memory in the variance dynamics. Second,
forecasting results based upon the same forecasting measures, namely, the mean
THE JOURNAL OF ENERGY AND DEVELOPMENT 280
square error (MSE), the root mean squared error (RMSE), the Theil inequality
coefficient (TIC), the logarithmic loss function (LL), and Mincer-Zarowitz re-
gression, reveal that the FIAPARCH model is the most appropriate forecasting
model in the cases of 1, 5, and 15 days ahead. The third contribution is that the
results of the one-day-ahead VaR and ES based on the skewed Student-t FIA-
PARCH outperforms those assuming normal or symmetric Student-t distributions.
The rest of the paper is set out as follows. We present five GARCH-type
models and the errors density models. In the subsequent section, we introduce the
VaR model and present the statistical accuracy of model-based VaR estimations.
Empirical results are then provided, followed by a summary of the studys results
and concluding remarks.
GARCH-Type Models
RiskMetrics Model: JP Morgan in 1994 published a new risk measure meth-
odology called RiskMetrics. Indeed, this methodology has become a reference in
risk management due to its simplicity. The RiskMetrics model is a normal in-
tegrated GARCH (1.1), where ARCH and GARCH parameters are prefixed.
The RiskMetrics model can be expressed as follows:
s
2
t
= w + 1 l e
2
t
+ ls
2
t1
1
where w = 0 and l is fixed at 0.94 for daily data; for weekly data l is equal to
0.97.
GARCH Model: T. Bollerslev has generalized the ARCH model created by R.
Engle.
8
This model (GARCH) was specified like an infinite ARCH. Hence, it
reduces parameters included in the model ARCH. The GARCH (p, q) model can
be written as follows:
s
2
t
= w +
q
i = 1
a
i
e
2
ti
+
p
i =1
b
j
s
2
tj
: 2
The lag operator allows us to specify the GARCH model as:
s
2
t
= w + a L e
2
t
+ b L s
2
t
3
where
a L = a
1
L + a
2
L
2
+ . . . + a
q
L
q
et b L = b
1
L + b
2
L
2
+ . . . + b
p
L
p
:
In reality, the GARCH model is a short-memory model since its autocorrelation
function is characterized by very slow decay over long periods (see T.
Bollerslev).
9
GARCH MODELS FOR ENERGY COMMODITIES 281
The FIGARCH Model: Many previous studies have shown that economic time
series usually are governed by long-memory processes. Indeed, the GARCH
model fails to take into account this stylized fact since it is a short- memory model.
To alleviate this problem, R. Baillie, T. Bollerslev, and H. Mikkelsen suggested
a new model, namely, the fractionally integrated GARCH model (FIGARCH),
which has the ability to distinguish between short memory and long memory in
conditional variance dynamics.
10
Formally, the FIGARCH (p.d.q) process can be
written as follows:
u L 1 L
d
_ _
e
2
t
= v+ 1 b L e
2
t
s
2
t
_ _
4
or
s
2
t
= v + b L s
2
t
+ 1 b L e
2
t
u L 1 L
d
e
2
t
= w 1 L
1
+ l L e
2
t
5
where (L) is the lag-operator, l L =
i =1
l
i
L
i
; and 0 d 1. l L is an infinite
summation, which in practice has to be truncated.
According to R. Baillie, T. Bollerslev, and H. Mikkelsen, l L should be
truncated at 1,000 lags. 1 L
d
is the fractional differencing operator. It can be
defined as follows:
1 L
d
=
k =0
r d +1 L
k
r k +1 r d k +1
=1 dL
1
2
d 1 L L
2
1
6
d 1 d 2 d L
3
. . . =1
k =1
c
k
d L
k
6
where c
1
d =d; c
2
d =
1
2
d 1 d ; etc.
The FIAPARCH Model: Y. Tse proposed a new model, FIAPARCH, which has
the ability to take into account both asymmetry and the long-memory feature in the
conditional variance.
11
The FIAPARCH model extends the symmetric FIGARCH
by adding the function je
t
j ge
t

d
of the APARCH process.The FIAPARCH
(p, d, q) can be specified as follows:
s
d
t
= v 1 b L
1
+ 1 1 b L
1
r L 1 L
d
_ _
je
t
jge
t

d
7
where d; g; and l are the model parameters. The FIAPARCH process can
incorporate some stylized facts of volatility dynamics. First, long memory in the
conditional variance, when 0 <d <1, then volatility is exhibited where d is in-
tegrated, and second asymmetry in the volatility as negative shocks provide a
higher effect on volatility than positive shocks do. Third, l is the power term in the
volatility structure. It should be specified by the data. Fourth, the FIAPARCH
model is a generalized FIGARCH model since the last one (FIGARCH) is a simple
case of the first process (FIAPARCH). Hence, the FIGARCH is equivalent to
FIAPARCH when g =0 and d =2. Thus, the FIAPARCH process outperforms the
FIGARCH.
The HYGARCH Model: J. Davidson has proposed a new GARCH-type
modelthe hyperbolic GARCH model (HYGARCH).
12
The authors aim is to
investigate whether the non-stationarity of the FIGARCH model holds. The
HYGARCH extends the FIGARCH model by introducing weights in the differ-
ence operator. The HYGARCH model is specified as follows:
s
2
t
= v 1 b L
1
+ 1 1 b L
1
r L 1 +a 1 L
d
_ _ _ _ _ _
e
2
t
: 8
The HYGARCH nests to FIGARCH a=1, while it nests to GARCH cases when
a=0.
The Density Models: In this sub-section we present the normal, Student-t, and
skewed Student-t error density models.
Assuming that the random variable is z;N 0; 1 , the log-likelihood of normal
distribution ( ) Norm L can be expressed as follows:
L
Norm
=
1
2
T
t = 1
ln 2p + ln s
2
t
_ _
+z
2
t
_
9
where T is the number of observations.
The random variable is z;ST 0; 1; n ; the log-likelihood function of the
Student-t distribution ( ) Stud L can be defined as follows:
L
Stud
= T lnG
y + 1
2
_ _
lnG
y
2
_ _

1
2
ln p n 2
_ _
1
2
T
t =1
ln s
2
t
_ _
+ 1 +n ln 1 +
z
2
t
s
2
t
n 2
_ _ _ _ _ _
10
where 2 < n and G is the gamma function. In contrast to the normal dis-
tribution, the Student-t distribution is estimated with an additional parameter n,
which stands for the number of degrees of freedom measuring the degree of fat-
tails in the density.
The random variable is z;SKST 0;1; k;n ; the log-likelihood of the skewed
Student-t distribution ( ) SkSt L is expressed as follows:
L
Skst
= T lnG
y +1
2
_ _
lnG
y
2
_ _

1
2
ln p n 2 + ln
2
k +
1
k
_ _
+ ln s
_ _
1
2
T
t = 1
ln s
2
t
_ _
+ 1 +n ln 1 + 1 +
sz
t
+m
2
n 2
_ _
k
2l
t
_ _ _ _
11
where I
t
=1 if z
t

m
=
s
or I
t
= 1 si z
t
<
m
=
s
, and k is an asymmetry parameter.
The constants m = m k; n and s =
s
2
k; n
_
are the mean and standard de-
viations of the skewed Student-t distribution:
m k; n =
G
n1
2
_ _
n 2
p
p
p
G
n
2
_ _
k
1
k
_ _
12
s
2
k; n = k
2
+
1
k
2
1
_ _
m
2
: 13
The value of ln k also can represent the degree of asymmetry in the residual
distribution. We note that when ln k =0, the skewed Student-t distribution nests
to the symmetric Student-t distribution, z;ST 0; 1; n .
The Value-at-Risk
The VaR Model: In this sub-section we present the VaRs values using a FIA-
PARCH model with skewed Student-t distribution innovation. We consider that
r
t
= m
t
+ e
t
14
m
t
= m +
m
i = 1
x
i
r
ti
+
n
j =1
u
j
e
tj
15
where x is an autoregressive (AR) process and u is a moving average (MA)
process.
The 2
t
=z
t
s
t
is governed by a FIAPARCH(p,d,q) process, and the innovations
z
t
are said to be described by the skewed Student-t distribution if
f z
t
k; v j =
2
k +
1
k
sg k sz
t
+ m v j
2
k +
1
k
sg k sz
t
+ m k v j
_
t
; if
z
t
< m=s
z
t
m=s
: 16
In the above equation, g n j denotes the symmetrical Student-t density and k is
the asymmetry parameter. The estimated VaR for the long- and short-trading
positions can be defined as follows:
a = P r
t
< VaR
t;L
_ _
= P
r
t
m
t
s
t
<
VaR
t;L
m
t
s
t
_ _
17
a = P r
t
> VaR
t;s
_ _
= P
r
t
m
t
s
t
>
VaR
t;s
m
t
s
t
_ _
: 18
In equations (17) and (18), VaR
t;L
and VaR
t;s
are the VaRs for, respectively, the
long- and the short-trading positions. They are written as follows
VaR
t;L
= m
t
+ st
a
v; k s
t
19
VaR
t;s
= m
t
+ st
1a
v; k s
t
20
where st
a
v; k is the left quantile at the a% of the skewed Student-t distribution
innovation. Correspondingly, st
1a
v; k is the right quantile of the skewed
Student-t distribution.
13
According to P. Lambert and S. Laurent and P. Wu and S.
Shieh, we can compute the one-day-ahead VaR estimated at time t 1 for the
long- and the short-trading positions.
14
Under the hypothesis of skewed Student-t
distribution, these VaRs are given by:
VaR
t;L
=

m
t
+ st
a
v; k
s
t
21
VaR
t;s
=

m
t
+ st
1a
v; k
s
t
: 22
Backtesting VaR Methodology: In order to backtest the accuracy for the esti-
mated VaRs, we calculated the empirical failure rates for both short- and long-
trading positions. The prescribed probability ranges from 0.25 percent to 5
percent. The failure rate is the number of times in which returns exceed (in ab-
solute value) the forecasted VaR. If the model is correctly specified, the failure
rate should be equal to the specified VaRs level. In this study, the backtesting
VaR is based on the Kupiec test.
15
The main idea of Kupiecs test is to estimate the
probability of observing a loss greater than the VaR amount. In order to test the
accuracy and to evaluate the performance of the model-based VaR estimates, P.
Kupiec provided a likelihood ratio test LR
UC
for testing whether the failure rate of
the model is statistically equal to the expected one (unconditional coverage).
Consider that N =
T
t = 1
I
t
is the number of exceptions in the sample size T. Then,
l
t + 1
=
1 if r
t + 1
< VaR
t + 1 t a j
0 if r
t + 1
VaR
t + 1 t a j
_
23
follows a binomial distribution, N;B T; a . If p = E
N
T
_ _
is the expected exception
frequency (i.e., the expected ratio of violations), then the hypothesis for testing
whether the failure rate of the model is equal to the expected one is expressed as
follows: H
0
: a=a
0
. a
0
is the prescribed VaR level. Thus, the appropriate likeli-
hood ratio statistic in the presence of the null hypothesis is given by:
LR
uc
= 2 log a
N
0
1 a
0

TN
_ _
+ 2log
N
T
_ _
N
1
N
T
_ _ _ _
TN
_ _
24
Under the null hypothesis, LR
UC
has a x
2
1 as an asymptotical distribution.
Consequently, a preferred model for VaR prediction should display the property
that the unconditional coverage measured by p =E N=T equals the desired
coverage level p
0
.
Empirical Analysis
Data and Preliminary Analysis: In this paper, we employ daily closing prices for
four major crude oil assets: WTI (West Texas Intermediate, Cushing price),
Europe Brent, New York Harbor conventional gasoline regular (NYHCGR), and
Los Angeles gas. Daily prices are expressed in dollars per barrel. For WTI, the
sample period runs from January 1986 to November 2008, while for Europe Brent
the sample period is from May 1987 to November 2008. The NYHCGR and Los
Angeles gas sample periods both commence in June 1986 and end in November
and August 2008, respectively. Data were extracted from the Energy Information
Administration (EIA).
16
The last 1,000 observations (43250 trading days) were
reserved for the out-of-sample forecasting exercise. The sample periods and the
number of daily observations are displayed in table 1.
Compared with previous studies, including those of P. Agnolucci, H. Kang
et al., M. Marzo and P. Zagalia, P. Narayan and S. Narayan, and P. Sadorsky, our
investigations are conducted on a long sample period, which involves some major
economic, financial, and political events: the 1990 Gulf War, the Asian financial
crises (1997), financial crises in some emerging countries such as Brazil and
Russia (1998), the Y2K scare (1999), the 9/11 attacks (2001), military action
against Iraq (2003), other geopolitical factors such as the Iranian nuclear program,
North Koreas missile launches (2002-2007), and the recent subprime lending
crises and the world economic recession (2008).
17
The WTI crude oil price
abruptly reached its peak at U.S.$ 147 per barrel on July 2008 and returned to
below U.S.$ 50 per barrel by December 2008.
The continuously compounded crude oil daily returns are computed as follows:
r
t
= 100 ln
P
t
P
t1
_ _
25
where r
t
and P
t
are the return in percent and the energy product closing price on
day (t), respectively. In line with previous studies, e.g., those of P. Sadorsky, R.
Faff and T. Brailsford, and C. Brooks and G. Persand, we employ two proxies to
measure crude oil daily volatility: the absolute r
t
j j and the squared return r
2
t
_ _
.
18
Daily descriptive statistics for each crude oil time series are displayed in table 2.
Statistical Properties of the Energy Assets: From table 2, we can observe that
all the energy time series exhibit similar statistical properties. As depicted in
figures 1b, 2b, 3b, and 4b, the crude oil return time series exhibited clustering
volatilitythat is periods of high volatility followed by periods of tranquility.
19
This inspection would reveal the presence of heteroskedasticity for the crude oil
return time series. The Jarque-Bera test statistic significantly rejects the null hy-
pothesis of Gaussian distribution. This result is confirmed by the kurtosis and
skewness statistics. More precisely, the kurtosis statistic ranges from 9.48 to
19.46, indicating the presence of fat-tails. With the exception of the Los Angeles
gas returnwhich has a positive skewness statistics (right-tailed)all the
skewness statistics are negative (WTI, Brent, and NYHCGR) and are significantly
different from zero, indicating that those crude oil returns are left-tailed. This
preliminary result is consistent with previous studies including, among others, C.
Aloui, C. Aloui et al., S. Mabrouk and C. Aloui, C. Brunetti and C. Gilbert, P. Giot
and S. Laurent, J.-C. Hung et al., H. Kang et al., and K. Narayan and S. Narayan.
20
Furthermore, figures 1c, 2c, 3c, and 4c report the QQ plots for each crude oil
return. These plots highlight the presence of large positive and negative returns,
explaining the strong rejection of the normal distribution hypothesis. This result is
confirmed by the Kernel density function plots for each crude oil daily returns
(figures 1d, 2d, 3d, and 4d). The descriptive statistics of crude oil daily returns are
presented in table 2.
We have employed the Ljung-Box Q statistic of order 20 for the squared
returns in order to investigate the presence of a white-noise process for the sample
returns. The Ljung-Box estimated statistic is significant, suggesting that we can
easily reject the null hypothesis of white noise. Thus, all the crude oil returns are
autocorrelated.
Table 1
ENERGY PRODUCTS DATA
a
Energy Product Sample Period Observations
European Brent 05/20/1987 11/12/2008 5,467
NYHCGR 06/02/1986 11/12/2008 5,650
WTI 01/02/1986 11/12/2008 5,772
Los Angeles Gas 06/02/1986 08/12/2008 5,582
a
NYHCGR = New York Harbor conventional gasoline regular, WTI = West Texas Intermediate.
In order to search for stationarity, integration, or fractional integration, we have
employed three alternative tests: the augmented Dickey-Fuller (ADF), the Phil-
lips-Perron (PP), and the Kwiatkowski, Phillips, Schmidt, and Shin (KPSS).
21
The
test results for the selected crude oil daily returns are displayed in table 3.
In order to investigate for the presence of unit roots and to test stationarity, we
present the results of the augmented Dickey-Fuller (ADF) and Phillips-Perron
(PP) unit root tests, along with the Kwiatkowski, Phillips, Schmidt, and Shin
(KPSS) stationarity test.
22
The ADF and PP tests reject the null hypothesis of
presence unit root for the four energy assets daily return time series. Therefore,
their return is governed by a 1 0 process, which has no long-range memory. For
the KPSS test, the results reveal the acceptance of the null hypothesis of statio-
narity at a 1-percent significance level for the same daily return.
Long-Memory Tests for the Daily Energy Assets Volatilities: In this study, we
consider two proxies of daily volatility: the squared and the absolute returns. To
test long memory, we employed diverse long-range memory tests including Los
test, the log-periodogram regression (GPH) of J. Geweke and S. Porter-Hudak, and
the Gaussian semi-parametric estimate test (GSP) of P. Robinson.
23
The choice of
this alternative test is justified by the fact that some authors cautioned against
using A. Los modified R=S in isolation. More precisely, several Monte Carlo
experiments conducted by V. Teverovsky, M. Taqqu, and W. Willinger on Los
statistic found that the modified R=S statistic is biased in favor of accepting the
null of no long range dependence as the bandwidth increases.
24
Empirical results
are displayed in table 4.
From these results, we can conclude that the energy assets absolute and squared
returns display long-range memory for a significance level of 1 percent. More
Table 2
DESCRIPTIVE STATISTICS OF CRUDE OIL DAILY RETURNS
a
Brent NYHCGR WTI Los Angeles Gas
Mean 0.0189 0.0175 0.0135 0.0279
Medium 0.0104 0.0347 0.0658 0
Maximum 17.3333 23.5291 19.1506 23.638
Minimum 36.1214 30.1397 40.6369 40.6369
SD 2.328 2.671 2.565 2.966
Skewness 0.820 0.208 0.929 0.146
Kurtosis 18.936 9.849 19.467 10.981
Jarque-Bera 58445.3 11082.1 66024.6 14832.9
{0.000} {0.000} {0.000} {0.000}
Q
2
(20) 603.44 984.37 465.27 307.54
Observations 5467 5650 5772 5582
a
NYHCGR = New York Harbor conventional gasoline regular, WTI = West Texas Intermediate.
Figure 1
Figure 2
Figure 3
Figure 4
precisely, Lo R/S and GPH tests do not reject the null hypothesis of no long-range
memory. The Geweke and Porter-Hudaks test has been implemented with dif-
ferent bandwidths: m = T
0.5
, m = T
0.6
, and m = T
0.7
. Consequently, the four energy
assets volatilities seem to be well described by a fractionally integrated process.
The Lo R/S test statistics are highly significant, indicating the presence of long-
range memory on those series volatilities. The GPH test statistics reveal that the
parameter (d) goes from 0.13 to 0.31 for the squared energy assets returns, while
for the absolute returns the long-memory parameter ranges from 0.24 to 0.49.
From these results, we are motivated to include in our study fractionary integrated
GARCH-type models.
Estimations of GARCH-Type Models: Tables 5 through 9 provide, respectively,
the estimation results of the RiskMetrics, GARCH, FIGARCH, FIAPARCH, and
HYGARCH models with normal, Student-t, and skewed Student-t distributions.
Table 5 (panel a) presents the estimation results for AR (1)-RiskMetrics model
for the selected energy time series under normal distribution. The table gives us
estimates results of the RiskMetrics model for the four energy commodity return
series. Since the holding period is set to one-day ahead, the b
1
is set to 0.94. To
check the adequacy of this GARCH-type model, we are referred to the output of
the Box-Pierce test on standardized residuals and squared standardized residuals,
the RBD test, the ARCH-LM test, and the Pearson goodness-of-fit statistic applied
after the estimation of the RiskMetrics model (including an AR (1) term). These
tests undoubtedly indicate that the RiskMetrics specification is not appropriate for
our sample data. Indeed, the RiskMetrics model is unable to consider for same
stylized facts of this sample data, such as asymmetry and long memory, in the
return volatilities.
The GARCH (1,1) estimated parameters a
1
and b
1
are all positive and sig-
nificantly different from zero. In addition, the sum of the estimated parameters
Table 3
UNIT-ROOT AND STATIONARITY TESTS
a
Brent NYHCGR WTI Los Angeles Gas
ADF test statistic 52.20 51.89 30.67 39.53
PP test statistic 71.09 71.45 77.64 66.32
KPSS test statistic 0.0626 0.0286 0.0917 0.060
{< 1} {< 1} {< 1} {< 1}
Obervations 5467 5650 5772 5582
a
NYHCGR = New York Harbor conventional gasoline regular; WTI = West Texas Intermediate;
MacKinnons 1-percent critical value is -3.435 for the ADF (augmented Dickey-Fuller) and PP
(Phillips-Perron) tests; the KPSS (Kwiatkowski, Phillips, Schmidt and Shin) critical value is 0.739 at
the 1-percent significance level.
Table 4
LOG-PERIODOGRAM REGRESSION (GPH), LOS R/S TEST, AND GAUSSIAN
SEMI-PARAMETRIC (GSP) ESTIMATE
a
jr
t
j r
2
t
Brent NYHCGR WTI LA Gas Brent NYHCGR WTI LA Gas
GPH
M= T
0.5
0.49 0.38 0.49 0.39 0.23 0.20 0.31 0.31
M= T
0.6
0.35 0.26 0.43 0.25 0.13 0.16 0.20 0.
M= T
0.7
0.34 0.24 0.28 0.23 0.23 0.17 0.18 0.16
Los R/S Test
1.35067 1.52429 1.40076 1.9913 1.64008 1.83822 2.0526 2.52543
{< 0.4} {< 0.2} {< 0.3} {< 0.025} {< 0.1} {< 0.05} {< 0.025} {< 0.005}
GSP Test
m = T/2 0.227 0.241 0.241 0.211 0.183 0.190 0.127 0.128
m = T/4 0.338 0.318 0.334 0.273 0.240 0.250 0.196 0.178
m = T/8 0.394 0.350 0.388 0.328 0.252 0.205 0.224 0.213
a
LA Gas = Los Angeles gas.
Table 5
AR(1)-RISKMETRICS MODEL ESTIMATION RESULTS
a
WTI Brent NYHCGR Los Angeles Gas
Panel a
a
1
0.06 0.06 0.06 0.06
b
1
0.94 0.94 0.94 0.94
Panel b
ln() -12840.3 -11774.9 -13124.1 -13574.3
AIC 4.453 4.311 4.649 4.866
Q(20) 23.88 25.71 30.79 48.69
Q
2
(20) 31.80 46.23 51.77 24.26
RBD(20) 34.30 54.29 57.00 25.03
ARCH(10) 2.11 3.26 3.36 1.29
P(60) 124.26*** 162.20*** 121.76*** 923.67***
a
ln() is the value of the maximized log-likelihood; AIC = the Akaike Information criterion; Q(20)
and Q
2
(20) are the Box-Pierce statistics for the remaining serial correlation for standardized and
squared standardized residuals, respectively; RBD(20) is the residual based diagnostic for
conditional heteroskedasticity using 20 lags; ARCH(10) is the LM-ARCH test of Engle using 10
lags; P(60) is the Pearson goodness-of-fit statistic for 60 cells; * = significance at the 10-percent
level, ** = significance at the 5-percent level, and *** = significance at the 1-percent level.
a
1
and b
1
of these models is less than one and thus ensures that the conditions for
stationary covariance hold. Moreover, this model shows clearly that crude oil and
gas daily returns display significant fat-tails. The Student-t df parameter is sig-
nificant at a 1-percent level for all the return time series and ranges from 3.19 (for
the Los Angeles gas) to 7.76 (for the NYHCGR) in the Student-t innovation
distributions. According to the log-likelihood and Akaike information criterion
(AIC), the GARCH model with skewed Student-t innovations distribution per-
forms better than the GARCH with normal or Student-t distribution for both crude
oil and gasoline return time series. Panel b of table 5 provides some diagnostic
tests, namely, the AIC, the Q-statistic for residuals and squared residuals, the
residual based diagnostic for conditional heteroskedasticity (RBD test), the LM-
ARCH, and the goodness-of-fit tests. With reference to the log-likelihood and AIC
information criteria, the skewed Student-t GARCH model surpasses normal and
Student-t GARCH models in the in-sample one-day-ahead volatility estimation.
Concerning the goodness-of-fit tests, the Ljung-Box test statistic applied for
standardized residuals and squared standardized residuals shows that there is no
remaining correlation.
25
This result is supported by the residual based test for
conditional heteroskedasticity using 20 lags since we do not reject the null hy-
pothesis of a correct model specification for the GARCH model.
The estimation results of the FIGARCH models using normal, Student-t, and
skewed Student-t innovations distributions are reported in table 7. As shown in
panel a, all the FIGARCH models under different innovations distributions are
able to capture the long-range memory phenomenon for both crude oil and
gasoline returns volatilities. Thus, all the long-memory parameters d strongly
reject the GARCH null hypothesis d =0 at a 1-percent significance level. For
the two gasoline assets, the long-memory parameter ranges from 0.38 to 0.46,
while it ranges from 0.60 to 1 for the two crude oil assets. With skewed dis-
tributed innovations, the FIGARCH estimation results reveal that crude oil daily
innovations and New York Harbor conventional gasoline regular are skewed to
the left, while the Los Angeles gas innovations distributions are skewed to the
right. In additions, the FIGARCH tail parameter is positively signed and sta-
tistically significant at the 1-percent level for all the energy assets. This result
proves that all the densities of all the standardized residuals displayed fat-tails.
With reference to the log-likelihood and the AIC (panel b), the estimation results
show that the FIGARCH models with skewed Student-t distribution perform
better than those with normal or Student-t distributions. Consequently, this
model is more apt to capture both the asymmetry and fat-tails in the energy
assets distributions. Turning to the goodness-of-fit tests (panel b), our results
demonstrate that we do not reject the null hypothesis of a correct model spec-
ification for all the energy assets since the Ljung-Box and the RBD test statistics
computed (with 20 lags) show no serial correlation and no remaining ARCH
effect.
T
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.
The FIAPARCH estimation results for the four energy assets are displayed in
table 8. According to the log-likelihood, the FIAPARCH model with skewed
Student-t distribution provides the best representation of all the time series. This
result is consistent with the conclusions of S. Degiannakis, S. Kang and S.-M.
Yoon, W. Hardle and J. Mungo, and C. Aloui and S. Mabrouk.
26
According to
these authors, the FIAPARCH models under skewed Student-t innovations dis-
tribution are best at capturing the characteristics of the empirical distribution.
Additionally, in all the FIAPARCH models, the tail parameter is positively signed
Table 10
OUT-OF-SAMPLE FORECASTING EVALUATION RESULTS (FOR 1, 5, AND
15 DAYS AHEAD)
a
AR (1) FIAPARCH (1.d.1)
Brent Los Angeles Gas NYCGR WTI
Horizon N t Skt N N t Skt N N t Skt N
1 MSE 102 76.12 75.67 0.39 0.40 0.28 10.22 17.11 17.4 35.85 37.3 37.11
day RMSE 10.1 8.72 8.69 0.62 0.63 0.52 3.19 4.13 4.17 5.98 6.10 6.09
TLC 0.93 0.92 0.92 0.04 0.04 0.03 0.52 0.59 0.59 0.66 0.66 0.66
LL 11.73 10.78 10.76 0.007 0.007 0.005 1.38 1.85 1.87 2.56 2.62 2.16
5 MSE 52.8 41.86 41.87 13.31 13.42 13.21 138.7 135.7 135.8 191 190.3 190.4
day RMSE 7.26 6.47 6.47 3.64 3.66 3.63 11.78 11.65 11.66 13.82 13.79 13.8
TIC 0.41 0.04 0.40 0.27 0.27 0.27 0.65 0.61 0.61 0.57 0.57 0.57
LL 4.77 4.32 4.32 3.29 3.30 3.29 4.10 4.49 4.53 4.89 4.87 4.87
15 MSE 171.9 166.3 166.2 33.92 32.88 32.74 277.8 273.6 272.5 212.6 211.6 211.5
day RMSE 13.11 12.9 12.89 5.82 5.73 5.72 16.67 16.54 16.51 14.59 14.55 14.54
TIC 0.55 0.55 0.55 0.36 0.36 0.36 0.69 0.67 0.67 0.56 0.56 0.56
LL 8.98 8.71 8.70 5.06 4.99 4.98 3.11 3.03 2.88 3.70 3.69 3.96
a
NYHGCR=New York Harbor conventional gasoline regular; WTI = West Texas Intermediate.
Table 11
MINCER-ZARNOWITZ REGRESSION RESULT
a
n.AR(1)-FIAPARCH t.AR(1)-FIAPARCH skt.AR(1)-FIAPAPRCH
a b R
2
a b R
2
a b R
2
Brent 1.35 0.66 0.046 1.08 0.72 0.049 1.04 0.73 0.049
WTI 0.12 0.98 0.116 0.13 0.98 0.116 0.85 0.76 0.119
NYHCGR 1.90 0.82 0.0929 1.52 0.86 0.0950 1.49 0.87 0.0959
Los Angeles Gas 0.40 0.036 0.0039 0.44 0.0.31 0.0040 0.44 0.032 0.0041
a
NYHCGR=New York Harbor conventional gasoline regular; WTI=West Texas Intermediate.
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9
and statistically significant for both crude oil and gasoline assets, indicating strong
evidence of fat-tail phenomenon. The four assets display strong evidence of
volatility asymmetry. More specifically, for these assets the APARCH d
parameter is positive and significant at the 1-percent level with estimated values
ranging from 1.15 (for the Europe Brent) to 1.72 (for NYHCG). The coefficient
of the asymmetric response of volatility to news g is positive and significant for
all the energy assets except for the NYHCGR. Based on this evidence, it seems
that generally the unexpected negative returns resulted in more volatility than
unexpected positive returns. Under skewed Student-t innovations distribution,
the FIAPARCH asymmetric parameters were negative and significant at the
1-percent, 5-percent, and 10-percent levels for WTI, Europe Brent, and NYHCG,
respectively; the same parameter was positive and significant at the 1-percent
level for Los Angeles gas. The densities of their standardized residuals are skewed
to the left, while we found insignificant values for the gasoline assets. Diagnostic
tests displayed in panel b show that the FIAPARCH model is able to take heter-
oskedasticity into consideration. In fact, the Ljung-Box and the RBD test statistics
provide evidence of correct model specification.
Table 9 (panel a) provides the estimation results for the hyperbolic GARCH
(HYGARCH) models assuming three alternative distributions, namely, normal,
Student-t, and skewed Student-t innovations. The hyperbolic parameters
log a HY are not statistically significant from zero for both crude oil and
gasoline returns with the exception of Los Angeles gas, with its hyperbolic pa-
rameters significant under the Student-t and skewed Student-t distributions, re-
spectively, at the same 5-percent level. This result is a clear sign that the GARCH
components covariance is stationary. As in the FIAPARCH model, the estimation
results reveal that under the skewed Student-t innovations distribution, the WTI,
Europe Brent crude oil, and NYHCGR daily returns are skewed to the left,
whereas the Los Angeles gas return displays a skewness to the right. The
HYGARCH asymmetry parameter has a negative sign and it is significant at the 1-
percent and 5-percent levels for WTI and Europe Brent, respectively. Further-
more, the tail parameter is significantly different from zero for all the energy
assets, indicating a presence of the fat-tail phenomenon. Using the log-likelihood
and the AIC, we can see that the HYGARCH model with skewed distributed
innovations performs better for both crude oil and gasoline assets. For the good-
ness-of-fit test (table 8, panel b), diagnostic results from the squared standardized
residuals and the RBD test reveal that the HYGARCH model is suitable to depict
heteroskedasticity exhibited in the energy assets time series since the RBD test
does not reject the null hypothesis of a correct model specification.
Overall, comparing the different GARCH-type models we can see that the
FIAPARCH with skewed Student-t distributed innovations outperforms the
GARCH, FIGARCH, and HYGARCH models for all the crude oil and gasoline
assets. This model is more appropriate to capture both long-range memory and
asymmetries in the return volatility. This result is quite similar to the findings of
W. Hardle and J. Mungo and C. Aloui and S. Mabrouk.
27
More specifically, the
authors have shown that the FIAPARCH model is observed to perform better in
modeling returns than other GARCH-type models.
The Forecasting Daily Volatility of Energy Commodities Results: Before
assessing the VaR and the ES, we have relied on some forecasting evaluation
measures, namely, MSE, RMSE, TIC, LL, and the Mincer-Zarnowitz regression to
investigate the accuracy of the FIAPARCH model in forecasting daily volatility
for 1, 5, and 15 days ahead. Results are provided in tables 10 and 11.
The results presented in table 10 show very clearly that for all samples the
FIAPARCH models under skewed Student-t distributions outperform normal and
Student-t FIAPARCH. More precisely, the FIAPARCHmodel has power ability in
forecasting daily energy commodity volatilities for 1, 5, and 15 days ahead. This
can be explained by the fact that this model under the skewed Student-t distri-
bution can account for asymmetry, tail fatness, and long memory in the volatility
behavior.
Likewise, the Mincer-Zarnowitz regression confirms that the skewed Student-t
FIAPARCH model performs very well in forecasting daily oil and gas volatilities.
Indeed, the R
2
provided in table 11 indicates the superiority of the FIAPARCH
model under skewed Student-t distribution in all the cases.
Value at Risk and Expected Shortfall Analysis
In our study, we assessed the one-day-ahead VaR and ES for the AR (1)-
FIAPARCH model under the three alternative distributionsnormal, Student-t,
and skewed Student-t for all energy commodities sample. To check the accuracy
of the VaR model, we have relied on Kupiecs LR tests. The a (VaR levels) ranges
from 0.05 to 0.0025 for short-trading position (positive returns), while it ranges
from 0.95 to 0.9975 for the long-trading position (negative returns). Likewise, the
expected shortfall (ES) is computed for both short- and long-trading positions for
the same levels. These results are provided in tables 12 through 15 (in-sample VaR
and ES) and tables 16 through 19 (out-of-sample VaR and ES).
The In-Sample VaR and ES Estimation Results: The in-sample VaR and ES and
backtesting test estimates are given in tables 12, 13, 14, and 15. These four tables
provide us with the results from the in-sample VaR and ES based on the FIA-
PARCH model assuming three alternative distributions (normal, Student-t, and
skewed Student-t distributions). Results confirm that normal distribution fails to
improve both long and short VaR quality. More precisely, the null hypothesis of
a correct model is not accepted, witnessed by the fact that the prefixed level (a) is
significantly different from the failure rate. These results can be explained by the
fact that all energy commodity series are not normally distributed. Indeed, the
entire time-series sample is skewed and fat-tailed; therefore, the symmetric normal
distribution has no ability to improve the VaR and ES results. Likewise, the
Student-t distribution, which takes into account tail fatness, provides quite similar
results to the normal case. However, the skewed Student-t FIAPARCH model is
more powerful than the other distributions since the VaR and ES accuracy are
improved for both short- and long-trading positions.
The Out-of-Sample VaR and ES Estimation Results: In this subsection we
compute the out-of-sample VaR model and ES for the one-day-ahead horizon.
Like the in-sample estimation, the out-of-sample estimation is based on the
FIAPARCH model under Gaussian, Student-t, and skewed Student-t distributions.
As many previous articles have suggested (e.g., S. Mabrouk and C. Aloui and T.
Tang and S. Shieh), in this work we have considered the last 1,000 observations
(the last five years) of our sample for the forecasting (out-of-sample).
28
Indeed, the
forecast updated the parameters of the AR (1)-FIAPARCH (1.d.1) model every 50
observations in the out-of-sample period.
Tables 16, 17, 18, and 19 display the estimate results of the out-of-sample VaR
and ES for both short- and long-trading positions. This estimation is based on
FIAPARCH model under normal, Student-t, and skewed Student-t innovations. Of
course we have kept the same horizon (one day ahead). The results show that the
normal distribution is unable to improve the VaR and ES accuracy since the
null hypothesis of a correct model is rejected. However the skewed Student-t
FIAPARCH models are more powerful compared to the normal and symmetric
Student-t models. More precisely, the FIAPARCH models, assuming the skewed
Student-t distribution, improve the VaR and ES qualities. Hence, the out-of-
sample VaR and ES results are quite similar to those provided in the in-sample
estimation cases.
Summary and Concluding Remarks
The main purpose of this study is to compute the one-day-ahead VaR and ES
for four energy commodities, i.e., WTI, Europe Brent, NYHCGR, and Los
Angeles gas. The selected crude oil and gas commodity time series cover in daily
frequency the sample period (1987-2008). Since all oil and gas time series are
characterized by some volatility-stylized facts, such as long-range memory,
asymmetry, and fat-tails in the return innovations, we have used five GARCH-
type modelsRiskMetrics, GARCH, FIGARCH, FIAPARCH, and the
HYGARCH modelswith three alternative innovations: the normal, the Student-t,
and the skewed Student-t. Empirical results reveal that the FIAPARCH model
with skewed Student-t seems to be better equipped to take into account
asymmetry, persistence, and fat-tails in the crude oil return innovations than the
other selected models. The out-of-sample forecasting exercise has been conducted
for 1, 5, and 15-day forecasting time horizons. In order to evaluate the forecasting
accuracy of the selected models, several criteria, including the MSE, RMSE, TIC,
LL, and Mincer-Zarnowitz regression, have been employed. The out-of-sample
results indicate the superiority of the FIAPARCH model under skewed Student-t
innovations distribution in predicting crude oil daily volatility. Furthermore, we
have computed the VaR and ES for both long- and short-trading positions. The
results reveal that in-sample and out-of-sample VaR and ES estimations are im-
proved when the estimations are based on the skewed Student-t FIAPARCH
model.
NOTES
1
P. Giot and S. Laurent, Market Risk in Commodity Markets: A VaR Approach, Energy
Economics, vol. 25, no. 5 (2003), pp. 435-57.
2
P. Sadorsky, Modeling and Forecasting Petroleum Futures Volatility, Energy Economics,
vol. 28, no. 4 (2006), pp. 467-88, and C. Brooks and G. Persand, Volatility Forecasting for Risk
Management, Journal of Forecasting, vol. 22, no. 1 (2003), pp. 1-22.
3
David Cabedo and Ismael Moya, Value-at-Risk Calculation through ARCH Factor Meth-
odology: Proposal and Comparative Analysis, European Journal of Operational Research, vol.
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Data available at www.econstats.com.
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In order to preserve space, these figures are not provided here but are available upon request
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22
In table 3 we report the results under the assumption of no intercept. Similar results are
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a Bartlett Kernel. These unit root and stationary test results should be considered with caution
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23
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24
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25
We should note that LM-ARCH tests confirmed the absence of ARCH effects in the residuals.
26
S. Degiannakis, Volatility Forecasting: Evidence from a Fractional Integrated Asymmetric
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2008-006, Humboldt-Universitat zu Berlin, Germany, 2008; and C. Aloui and S. Mabrouk, op. cit.
27
W. Hardle and J. Mungo, op. cit., and C. Aloui and S. Mabrouk, op. cit.
28
S. Mabrouk and C. Aloui, op. cit., and T. L. Tang and S. J. Shieh, Long Memory in Stock
Index Futures Markets: A Value-at-Risk Approach, Physica, vol. 366 (July 2006), pp. 437-48.

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