Backtesting is a framework that uses historical data to validate financial models, including trading strategies and risk management models. Depending on the goals of validation, financial professional use more than one indicator or methodology to measure the effectiveness of financial models.
Backtesting is routinely performed in trading and risk management. As a result, there are a number of dedicated backtesting techniques specific to these two areas.
In trading, common backtesting techniques include:
In risk management, backtesting is generally applied to value-at-risk (VaR) and is also known as VaR backtesting. There are various VaR backtesting techniques, such as:
Develop, manage, review, and challenge internal and regulatory models.