Testing VaR Accuracy for CDS Portfolios Using Historical Simulation and Delta-Normal Models

Abstract

This paper studies the accuracy of the VaR using the Delta-Normal and Historical approaches in measuring the risk of CDS portfolios in three different zones, US, Europe and Asia, for the period March 2013-November 2015. The portfolios consist exclusively of CDS of high rated banks and financial institutions. We found that at the 95% confidence level both approaches were accurate using equal weights over 500 days. However, at the 99% level, the Delta-Normal method underestimated the VaR except for Aisa portfolio even with the use of exponential weights for different values of λ. The Historical Simulation approach was more accurate because it accounted for fat tails and therefore avoided nonstationarity. Both approaches failed in accurately measuring the VaR over 50 days.