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# ASSIGNMENT 9

## e. What should we do if data is not normal?

a. The normal distribution, also called the Gauss distribution, is the probability
distribution most widely used in various statistical analyzes. The standard
normal distribution is the normal distribution which has an average of zero and
one standard deviation.

## b. The normal distribution is the most important probability distribution

in statistics because it fits many natural phenomena. For example, heights,
blood pressure, measurement error, and IQ scores follow the normal
distribution. It is also known as the Gaussian distribution and the bell curve.

The normal distribution is a probability function that describes how the values
of a variable are distributed. It is a symmetric distribution where most of the
observations cluster around the central peak and the probabilities for values
further away from the mean taper off equally in both directions. Extreme
values in both tails of the distribution are similarly unlikely.

c. Imply put, a z-score is the number of standard deviations from the mean a data
point is. But more technically it’s a measure of how many standard deviations
below or above the population mean a raw score is. A z-score is also known as
a standard score and it can be placed on a normal distribution curve. Z-scores
range from -3 standard deviations (which would fall to the far left of the
normal distribution curve) up to +3 standard deviations (which would fall to
the far right of the normal distribution curve). In order to use a z-score, you
need to know the mean μ and also the population standard deviation σ.

## d. A normal distribution has a bell-shaped density curve described by its mean

and standard deviation . The density curve is symmetrical, centered about its
mean, with its spread determined by its standard deviation. The height of a
normal density curve at a given point x is given by
The Standard Normal curve, shown here, has mean 0 and standard deviation 1. If a
dataset follows a normal distribution, then about 68% of the observations will fall
within of the mean , which in this case is with the interval (-1,1). About 95% of the
observations will fall within 2 standard deviations of the mean, which is the interval (-
2,2) for the standard normal, and about 99.7% of the observations will fall within 3
standard deviations of the mean, which corresponds to the interval (-3,3) in this case.
Although it may appear as if a normal distribution does not include any values beyond
a certain interval, the density is actually positive for all values, . Data from any
normal distribution may be transformed into data following the standard normal
distribution by subtracting the mean and dividing by the standard deviation

e. Many practitioners suggest that if your data are not normal, you should do a
nonparametric version of the test, which does not assume normality. From my
experience, I would say that if you have non-normal data, you may look at the
nonparametric version of the test you are interested in running. But more important, if
the test you are running is not sensitive to normality, you may still run it even if the
data are not normal.

2. What is the difference between expected shortfall and value at risk? What is the
theoretical advantage of expected shortfall over value at risk?

Expected Shortfall : A measure that produces better incentives for traders than VAR is
expected shortfall. This is also sometimes referred to as conditional VAR, conditional value at
risk, conditional tail expectation, or tail loss.

Value At Risk : Value-at-risk is defined as the loss level that will not be exceeded with a
certain confidence level during a certain period of time.

Expected Shortfall advantage over Value At Risk : Expected Shortfall has better theoretical
properties than Value At Risk. If two portfolios are combined, the total Expected Shortfall
usually decreases - reflecting the benefits of diversification and certainly never increases. By
contrast, the total Value At Risk can and in practice occasionally does increase.

3. A fund manager announces that the fund’s one-month 95% value at risk is 6% of the size
of the portfolio being managed. You have an investment of \$100,000 in the fund. How do you
interpret the portfolio manager’s announcement?

There is a 5% chance that you will lose \$6,000 or more during a one month period

4. Suppose that a mean of asset price is \$50 and standard-deviation would be \$1.51. If we
assume that the change in the asset price is normally distributed, we can be 90% certain that
the asset price will be between?

If we assume that the change in the asset price is normally distributed, we can be 90% certain
that the asset price will be between
50 − 1.64 × 1.51 = \$47.52, and
50 + 1.65 × 1.51 = \$52.49 at the end of the day.

5. Suppose that we back-test a value at risk model using 1,000 days of data. The value at
risk confidence level is 99% and we observe 15 exceptions. Should we reject the model at the
5% confidence level?

p = 0.01
m = 15
n = 1000.
Kupiec’s test statistic is:

= ….

## −2ln[0.999985 × 0.0115] + 2ln[(1 − 15/1000)985 × (15/1000)15] = 2.19

The result is less than 3.84. So we should not therefore reject the model

6. Suppose that the standard deviation of daily changes in the portfolio value is \$2 million
and the first-order autocorrelation of daily changes is 0.2.
Calculate:

a. The variance and standard deviation of the change in the portfolio value over four days

a. Variance =

## = 22 [ 4 + 2 (4-1) 0.2 + 2 (4-2) 0.22 + 2 (4-3) 0.23]

= 4 [4 + 1.2 + 0.16 + 0.016]
= 4 [5.376]
= 21.504

## b. The five-day 90% VAR

4.637240559 x N-1(0.90)
4.6370559 x 1.281551566 = 5.9428629

## c. Ratio of the one-day standard deviation

4.637240559 / 2 = 2.31862028

7. Suppose the VARs calculated for two segments of a business are \$50 million and \$92
million.

The correlation between the losses is estimated as 0.7. An estimate of the total VAR is?