Modelling dynamic portfolio risk using risk drivers of elliptical processes
AbstractThe situation of a limited availability of historical data is frequently encountered in portfolio risk estimation, especially in credit risk estimation. This makes it difficult, for example, to find statistically significant temporal structures in the data on the single asset level. By contrast, there is often a broader availability of cross-sectional data, i.e. a large number of assets in the portfolio. This paper proposes a stochastic dynamic model which takes this situation into account. The modelling framework is based on multivariate elliptical processes which model portfolio risk via sub-portfolio specific volatility indices called portfolio risk drivers. The dynamics of the risk drivers are modelled by multiplicative error models (MEMs)-as introduced by Engle [Engle, R.F., 2002. New frontiers for ARCH models. J. Appl. Econom. 17, 425-446]-or by traditional ARMA models. The model is calibrated to Moody's KMV Credit Monitor asset returns (also known as firm-value returns) given on a monthly basis for 756 listed European companies at 115 time points from 1996 to 2005. This database is used by financial institutions to assess the credit quality of firms. The proposed risk drivers capture the volatility structure of asset returns in different industry sectors. A characteristic cyclical as well as a seasonal temporal structure of the risk drivers is found across all industry sectors. In addition, each risk driver exhibits idiosyncratic developments. We also identify correlations between the risk drivers and selected macroeconomic variables. These findings may improve the estimation of risk measures such as the (portfolio) Value at Risk. The proposed methods are general and can be applied to any series of multivariate asset or equity returns in finance and insurance.
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Bibliographic InfoArticle provided by Elsevier in its journal Insurance: Mathematics and Economics.
Volume (Year): 44 (2009)
Issue (Month): 2 (April)
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Web page: http://www.elsevier.com/locate/inca/505554
Portfolio risk modelling Elliptical processes Credit risk Multiplicative error model Volatility clustering Moody's KMV Credit Monitor database;
Other versions of this item:
- Schmidt, Rafael & Schmieder, Christian, 2007. "Modelling dynamic portfolio risk using risk drivers of elliptical processes," Discussion Paper Series 2: Banking and Financial Studies 2007,07, Deutsche Bundesbank, Research Centre.
- C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
- C16 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Econometric and Statistical Methods; Specific Distributions
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
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