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Forecasting Portfolio Risk in Normal and Stressed Markets

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Author Info
Vineer Bhansali
Mark B. Wise
Abstract

The instability of historical risk factor correlations renders their use in estimating portfolio risk extremely questionable. In periods of market stress correlations of risk factors have a tendency to quickly go well beyond estimated values. For instance, in times of severe market stress, one would expect with certainty to see the correlation of yield levels and credit spreads go to -1, even though historical estimates will miss this region of correlation. This event might lead to realized portfolio risk profile substantially different from what was initially estimated. The purpose of this paper is to explore the correlation driven effects on fixed income portfolio risks. To achieve this, we propose a methodology to estimate portfolio risks in both normal and stressed times using confidence weighted forecast correlations.

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File URL: http://arxiv.org/abs/nlin/0108022
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File URL: http://arxiv.org/pdf/nlin/0108022
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Paper provided by arXiv.org in its series Quantitative Finance Papers with number nlin/0108022.

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Date of creation: Aug 2001
Date of revision: Sep 2001
Handle: RePEc:arx:papers:nlin/0108022

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  1. Alejandro Reveiz Herault, 2008. "The Factor-Portfolios Approach to Asset Management using Genetic Algorithms," BORRADORES DE ECONOMIA 004626, BANCO DE LA REPÚBLICA. [Downloadable!]
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  2. Celso Brunetti & Alessio Caldarera, 2006. "Asset Prices and asset Correlations in Illiquid Markets," Computing in Economics and Finance 2006 331, Society for Computational Economics. [Downloadable!]
    Other versions:
  3. Linda Allen & Anthony Saunders, 2004. "Incorporating Systemic Influences Into Risk Measurements: A Survey of the Literature," Journal of Financial Services Research, Springer, vol. 26(2), pages 161-191, October. [Downloadable!] (restricted)
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