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Steps in Applying Extreme Value Theory to Finance: A Review

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  • Younes Bensalah
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    File URL: http://www.bankofcanada.ca/wp-content/uploads/2010/01/wp00-20.pdf
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    Paper provided by Bank of Canada in its series Working Papers with number 00-20.

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    Length: 31 pages Abstract: Extreme value theory (EVT) has been applied in fields such as hydrology and insurance. It is a tool used to consider probabilities associated with extreme and thus rare events. EVT is useful in modelling the impact of crashes or situations of extreme stress on investor portfolios. Contrary to value-at-risk approaches, EVT is used to model the behaviour of maxima or minima in a series (the tail of the distribution). However, implementation of EVT faces many challenges, including the scarcity of extreme data, determining whether the series is “fat-tailed,” choosing the threshold or beginning of the tail, and choosing the methods of estimating the parameters. This paper focuses on the univariate case; the approach is not easily extended to the multivariate case, because there is no concept of order in a multidimensional space and it is difficult to define the extremes in the multivariate case. Following a review of the theoretical literature, univariate EVT techniques are applied to a series of daily exchange rates of Canadian/U.S. dollars over a 5-year period (1995–2000).
    Date of creation: 2000
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    Handle: RePEc:bca:bocawp:00-20

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    Keywords: impact of crashes; implementation;

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    Cited by:
    1. Suarez, Ronny, 2009. "Improving Modeling of Extreme Events using Generalized Extreme Value Distribution or Generalized Pareto Distribution with Mixing Unconditional Disturbances," MPRA Paper 17482, University Library of Munich, Germany.
    2. Younes Bensalah, 2002. "Asset Allocation Using Extreme Value Theory," Working Papers 02-2, Bank of Canada.
    3. Suarez, R, 2001. "Improving Modeling of Extreme Events using Generalized Extreme Value Distribution or Generalized Pareto Distribution with Mixing Unconditional Disturbances," MPRA Paper 17443, University Library of Munich, Germany.
    4. Pamela Cardozo, . "Valor en Riesgo de los Activos Financieros Colombianos Aplicando la Teoría de Valor Extremo," Borradores de Economia 304, Banco de la Republica de Colombia.

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