Market Risk Measurement for Crude Oil: A Wavelet Based VaR Approach

With the development of technology and financial engineering tools, oil markets are more competitive and volatile than ever before. This places the accurate and reliable measurement of market risks in the crucial position for both investment decision and hedging strategy designs. This paper tackles the measurement of risks from a Value at Risk (VaR) perspective. Since traditional ARMA-GARCH approach doesn´t suffice, this paper proposes ex-ante based approach for hybrid algorithm design and further applies this methodology with a wavelet approach to VaR estimates. Empirical studies of the proposed Wavelet Decomposed Value at Risk (WDVaR) have been conducted on two major oil markets (I.e. WTI & Brent). Experiment results suggest that the performance of WDVaR improves upon ARMA-GARCH model at higher confidence levels. Meanwhile, WDVaR offer considerable flexibility during modeling process. WDVaR can be tailored to specific market characteristics and its performance can be further improved with more careful parameter tuning.