An Empirical Study of Value at Risk in the Chinese Stock Market

Abstract: Nowadays, value at risk (VaR) has developed into a standard indicator in the financial risk measuring field. The aim of this study is not only to measure the risk of the Chinese stock market using VaR methods, but also to value whether the downside risk is priced in the expected return in the market. This study estimates VaR of six indices using four approaches at both 95% and 99% confidence levels. Then by conducting the Kupiec backtest, we find the best fitted method for each sample. We conclude that the approach of historical simulation with volatility is the best one for most of the samples, and the non-parametric methods fit much better than the parametric ones in the Chinese stock market. Furthermore, this study uses these best VaR estimates to test the intertemporal risk-return trade-off between the downside risk and the expected return. The positive risk-return relation is proved when we consider control variables, which are the one-month-lag return and a dummy variable for financial crisis.