Back-testing Studies on the FactSet Short-term Risk Model During the COVID-19 Outbreak

It became a common theme post-2008 that VaR is not able to capture extreme events. This is only true if VaR is assessed based on a model of “Category 1” as described in Part 1 and referred throughout this series, i.e., models based on the normality or historical assumptions that believe that the future can only repeat history and/or the probability of extreme events dies out to zero with exponential speed. VaR based on models that incorporate time-varying probability of disasters (“the Noah effect”) can provide a statistically sound characterization of potentially large losses that is meaningful for investment management [1], [2].