Estimating Value at Risk From Implied Volatilities Using Machine Learning Meth-Ods and Quantile Regression

Abstract

In this study we propose a semi-parametric, parsimonious Value at Risk forecasting model, based on quantile regression and machine learning methods, combined with readily available market prices of option contracts from the over-the-counter foreign exchange rate interbank market. We aim at improving existing methods for VaR prediction of currency investments using machine learning. We employ two different methods - ensemble methods and neural networks.
 Explanatory variables are implied volatilities with plausible economic interpretation. The forward-looking nature of the model, achieved by the application of implied volatilities as risk factors, ensures that new information is rapidly reflected in Value at Risk estimates. To the best of our knowledge, this paper is the first to utilize information in the volatility surface, combined with machine learning and quantile regression, for VaR prediction of currency investments.
 The proposed ensemble models achieve good estimates across all quantiles. The light gra-dient-boosting machine model and the categorical boosting model both yield estimates which are better than, or equal to, those of the benchmark model. The neural network models are in general quite unstable.