The Effect of Dynamic Exponential Decay Factor on Volatility and VaR

Marius Botha, Gary van Vuuren and Paul Styger

Value at Risk models heavily on the accuracy of price volatility estimates to measure capital that could potentially be lsot over given time horizons. Volatility measured by equally weighting instruments price returns in often erroneous, but employing exponential envelope weighting largely circumvents the inaccuracies. The steepness of the envelope applied to returns depends upon a single number . assumed unique and constant in any given market. This paper examines the historical evolution of for South African-specific data and shows it it vary consntatly and significantly. The effects of these changes on volatility, correlation and ultimately, VaR, are also examined.

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