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Stressing correlations and volatilities — A consistent modeling approach

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  • Becker, Christoph
  • Schmidt, Wolfgang M.
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    Abstract

    We propose a new approach to the definition of stress scenarios for volatilities and correlations. Correlations and volatilities depend on a common market factor, which is the key to stressing them in a consistent and intuitive way. Our approach is based on a new asset price model where correlations and volatilities depend on the current state of the market, which captures market-wide movements in equity-prices. For sample portfolios we compare correlations and volatilities in a normal market and under stress and explore consequences for value-at-risk.

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    File URL: http://www.sciencedirect.com/science/article/pii/S092753981200093X
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 21 (2013)
    Issue (Month): C ()
    Pages: 174-194

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    Handle: RePEc:eee:empfin:v:21:y:2013:i:c:p:174-194

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    Web page: http://www.elsevier.com/locate/jempfin

    Related research

    Keywords: Correlation; Volatility; Basel III; GARCH models;

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    8. Uwe Kuchler & Eckhard Platen, 2000. "Strong Discrete Time Approximation of Stochastic Differential Equations with Time Delay," Research Paper Series 44, Quantitative Finance Research Centre, University of Technology, Sydney.
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    10. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-50, July.
    11. Uwe Küchler & Michael Sørensen, 2010. "A simple estimator for discrete-time samples from affine stochastic delay differential equations," Statistical Inference for Stochastic Processes, Springer, vol. 13(2), pages 125-132, June.
    12. Francis X. Diebold & Kamil Yilmaz, 2008. "Macroeconomic Volatility and Stock Market Volatility, Worldwide," NBER Working Papers 14269, National Bureau of Economic Research, Inc.
    13. Eraker, Bjorn, 2001. "MCMC Analysis of Diffusion Models with Application to Finance," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(2), pages 177-91, April.
    14. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
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