Basel II and the Risk Management of Basket Options with Time-Varying Correlations
AbstractThe impact of jumps, regime switches, and linearly changing correlation term structures on the risk management of basket options has been examined in this paper. First, the results show that there is an asymmetric correlation effect on the value-at-risk of basket options. Second, the time at which a correlation shock occurs during the life of an option is particularly important for hedged basket options. Finally, the square-rootof- time rule can lead to severe underestimation of value-at-risk for basket options with time-varying correlations – for some cases, even by a factor exceeding the minimum regulatory stress factor.
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Bibliographic InfoArticle provided by International Journal of Central Banking in its journal International Journal of Central Banking.
Volume (Year): 2 (2006)
Issue (Month): 4 (December)
Find related papers by JEL classification:
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
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