Extreme Value Theory versus traditional GARCH approaches applied to financial data: a comparative evaluation

Although stock prices fluctuate, the variations are relatively small and are frequently assumed to be normally distributed on a large time scale. But sometimes these fluctuations can become determinant, especially when unforeseen large drops in asset prices are observed that could result in huge losses or even in market crashes. The evidence shows that these events happen far more often than would be expected under the generalised assumption of normally distributed financial returns. Thus it is crucial to model distribution tails properly so as to be able to predict the frequency and magnitude of extreme stock price returns. In this paper we follow the approach suggested by McNeil and Frey in 2000 and combine GARCH-type models with the extreme value theory to estimate the tails of three financial index returns ¿ S&P 500, FTSE 100 and NIKKEI 225 ¿ representing three important financial areas in the world. Our results indicate that EVT-based conditional quantile estimates are more accurate than those from conventional GARCH models assuming normal or Student¿s t distribution innovations when doing not only in-sample but also out-of-sample estimation. Moreover, these results are robust to alternative GARCH model specifications. The findings of this paper should be useful to investors in general, since their goal is to be able to forecast unforeseen price movements and take advantage of them by positioning themselves in the market according to these predictions

Q-Learning-based financial trading: some results and comparisons

In this paper, we consider different financial trading systems (FTSs) based on a Reinforcement Learning (RL) methodology known as Q-Learning (QL). QL is a machine learning method which real-time optimizes its behavior in relation to the responses it gets from the environment as a consequence of its acting. In the paper, first we introduce the essential aspects of RL and QL which are of interest for our purposes, then we present some original and differently configurated FTSs based on QL, finally we apply such FTSs to eight time series of daily closing stock returns from the Italian stock market