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Dependence structure of risk factors and diversification effects

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  • Zhou, Chen

Abstract

In this paper, we study the aggregated risk from dependent risk factors under the multivariate Extreme Value Theory (EVT) framework. We consider the heavy-tailedness of the risk factors as well as the non-parametric tail dependence structure. This allows a large range of models on the dependence. We assess the Value-at-Risk of a diversified portfolio constructed from dependent risk factors. Moreover, we examine the diversification effects under this setup.

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File URL: http://www.sciencedirect.com/science/article/B6V8N-4YBMF6T-1/2/3bcf7a093a13b8523c9dd29e13bdb69e
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Bibliographic Info

Article provided by Elsevier in its journal Insurance: Mathematics and Economics.

Volume (Year): 46 (2010)
Issue (Month): 3 (June)
Pages: 531-540

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Handle: RePEc:eee:insuma:v:46:y:2010:i:3:p:531-540

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Web page: http://www.elsevier.com/locate/inca/505554

Related research

Keywords: Aggregated risk Diversification effect Multivariate extreme value theory;

References

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  1. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  2. Namwon Hyung & Casper G. de Vries, 2005. "Portfolio Selection with Heavy Tails," Tinbergen Institute Discussion Papers 05-009/2, Tinbergen Institute, revised 04 Oct 2006.
  3. Hartmann, Philipp & Straetmans, Stefan & de Vries, Casper, 2001. "Asset market linkages in crisis periods," Working Paper Series 0071, European Central Bank.
  4. Namwon Hyung, 2005. "Portfolio Diversification Effects of Downside Risk," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 3(1), pages 107-125.
  5. Ibragimov, Rustam & Walden, Johan, 2008. "Portfolio diversification under local and moderate deviations from power laws," Insurance: Mathematics and Economics, Elsevier, vol. 42(2), pages 594-599, April.
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  7. Christian Gourieroux & J. P. Laurent & Olivier Scaillet, 2000. "Sensitivity Analysis of Values at Risk," Econometric Society World Congress 2000 Contributed Papers 0162, Econometric Society.
  8. Namwon Hyung & Casper G. de Vries, 2005. "Portfolio Diversification Effects of Downside Risk," Tinbergen Institute Discussion Papers 05-008/2, Tinbergen Institute.
  9. Jansen, Dennis W & de Vries, Casper G, 1991. "On the Frequency of Large Stock Returns: Putting Booms and Busts into Perspective," The Review of Economics and Statistics, MIT Press, vol. 73(1), pages 18-24, February.
  10. Jansen, Dennis W. & Koedijk, Kees G. & de Vries, Casper G., 2000. "Portfolio selection with limited downside risk," Journal of Empirical Finance, Elsevier, vol. 7(3-4), pages 247-269, November.
  11. Arzac, Enrique R. & Bawa, Vijay S., 1977. "Portfolio choice and equilibrium in capital markets with safety-first investors," Journal of Financial Economics, Elsevier, vol. 4(3), pages 277-288, May.
  12. Susmel, Raul, 2001. "Extreme observations and diversification in Latin American emerging equity markets," Journal of International Money and Finance, Elsevier, vol. 20(7), pages 971-986, December.
  13. Ser-Huang Poon, 2004. "Extreme Value Dependence in Financial Markets: Diagnostics, Models, and Financial Implications," Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 581-610.
  14. Walden, Johan & Ibragimov, Rustam, 2008. "Portfolio Diversification under Local and Moderate Deviations from Power Laws," Scholarly Articles 2640586, Harvard University Department of Economics.
  15. Christian Gourieroux & Jean-Paul Laurent & Olivier Scaillet, 2000. "Sensitivity Analysis of Values at Risk," Working Papers 2000-05, Centre de Recherche en Economie et Statistique.
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Citations

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Cited by:
  1. Chollete, Loran & de la Pena , Victor & Lu, Ching-Chih, 2009. "International Diversification: An Extreme Value Approach," UiS Working Papers in Economics and Finance 2009/26, University of Stavanger.
  2. Zhou, Chen, 2013. "The impact of imposing capital requirements on systemic risk," Journal of Financial Stability, Elsevier, vol. 9(3), pages 320-329.
  3. Moore, Kyle & Sun, Pengfei & de Vries, Casper G. & Zhou, Chen, 2013. "The cross-section of tail risks in stock returns," MPRA Paper 45592, University Library of Munich, Germany.
  4. Kyle Moore & Pengfei Sun & Casper de Vries & Chen Zhou, 2013. "Shape Homogeneity and Scale Heterogeneity of Downside Tail Risk," Working Papers 13-13, Chapman University, Economic Science Institute.
  5. Marco Rocco, 2011. "Extreme value theory for finance: a survey," Questioni di Economia e Finanza (Occasional Papers) 99, Bank of Italy, Economic Research and International Relations Area.
  6. Gatzert, Nadine & Kellner, Ralf, 2011. "The influence of non-linear dependencies on the basis risk of industry loss warranties," Insurance: Mathematics and Economics, Elsevier, vol. 49(1), pages 132-144, July.
  7. Tong, Bin & Wu, Chongfeng & Xu, Weidong, 2012. "Risk concentration of aggregated dependent risks: The second-order properties," Insurance: Mathematics and Economics, Elsevier, vol. 50(1), pages 139-149.
  8. Maarten van Oordt & Chen Zhou, 2011. "Systematic risk under extremely adverse market condition," DNB Working Papers 281, Netherlands Central Bank, Research Department.
  9. Kellner, Ralf & Gatzert, Nadine, 2013. "Estimating the basis risk of index-linked hedging strategies using multivariate extreme value theory," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4353-4367.
  10. Moore, Kyle & Sun, Pengei & de Vries, Casper G. & Zhou, Chen, 2013. "The drivers of downside equity tail risk," MPRA Paper 45591, University Library of Munich, Germany.

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