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Market Insight - 2013 Year in Review: Risk Model Backtesting - February 2014

This Market Insight presents the results of an annual backtesting study, using RiskManager, applied to four standard risk models.  The study includes fixed income and equity portfolios during the 2013 calendar year.  While the first half of 2013 was quiet, volatility increased after June 2013. For fixed income portfolios, comparing ex-ante risk forecasts with ex-post returns, the more reactive models showed some underestimation of risk in the turbulent period, while the more stable historical model produced better forecasts on average  (thanks to the 2008 crisis data being included). For equity portfolios, the least responsive model overestimated risk throughout 2013, while the more reactive models performed better. Looking back over the past three years of these backtesting studies, and accounting for both over and underestimation of risk, we see that different models have performed better in different years.  This raises both immediate practical implications and longer term questions, which we discuss in the conclusion.