Using Value-at-Risk to Estimate Downside Residential Market Risk

Abstract

Conditional Value-at-Risk (VaR) is currently used by the banking industry to measure market risk as it relates to equity risk, currency risk, interest rate risk, and commodity risk. This paper examines the downside market risk in residential housing using various conditional volatility models. Although there is controversy surrounding the use of VaR as a risk management tool, these concerns are explored through various modeling scenarios. Furthermore, an alternative portfolio is constructed minimizing VaR exposure as a portfolio constraint. The findings reveal that the conditional volatility models are especially useful when the current downside residential market risk is time-period dependent because the traditional risk measure based on a longer time series is less influenced by short-term extremes.