Asset Allocation Using Extreme Value Theory
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Bibliographic InfoPaper provided by Bank of Canada in its series Working Papers with number 02-2.
Length: 29 pages Abstract: This paper examines asset allocation strategies in an extreme value at risk (VaR) framework in which the risk measure is the p-quantile from the extreme value distribution. The main focus is on the allocation problem faced by an extremely risk-averse institution, such as a central bank. The optimal portfolio in terms of excess return over the risk-free rate per unit of risk is also described. An example of asset allocation is presented using a 1-year treasury bill and a 5-year zero-coupon bond. The allocation is conducted using different risk measures: duration, standard VaR, the quantile of the empirical distribution, and the quantile of the extreme distribution. An approximation procedure is described for the allocation of N-assets. An example of allocating eight Canadian treasuries and bonds is given (covering the whole Canadian term structure). The implications of the results on optimal allocation of capital under stressed market conditions are discussed. Some practical issues concerning the use of the results are described, such as who should allocate capital based on extreme values.
Date of creation: 2002
Date of revision:
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Find related papers by JEL classification:
- C0 - Mathematical and Quantitative Methods - - General
- C4 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics
- C5 - Mathematical and Quantitative Methods - - Econometric Modeling
- G1 - Financial Economics - - General Financial Markets
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- Younes Bensalah, 2000. "Steps in Applying Extreme Value Theory to Finance: A Review," Working Papers 00-20, Bank of Canada.
- Lan-chih Ho & John Cadle & Michael Theobald, 2011. "An analysis of risk-based asset allocation and portfolio insurance strategies," Review of Quantitative Finance and Accounting, Springer, vol. 36(2), pages 247-267, February.
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