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Conditional Volatility and Correlations of Weekly Returns and the VaR Analysis of 2008 Stock Market

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  • Pesaran, M.H.

Abstract

Modelling of conditional volatilities and correlations across asset returns is an integral part of portfolio decision making and risk management. Over the past three decades there has been a trend towards increased asset return correlations across markets, a trend which has been accentuated during the recent financial crisis. We shall examine the nature of asset return correlations using weekly returns on futures markets and investi- gate the extent to which multivariate volatility models proposed in the literature can be used to formally characterize and quantify market risk. In particular, we ask how adequate these models are for modelling market risk at times of financial crisis. In doing so we consider a multivariate t version of the Gaussian dynamic conditional correlation (DCC) model proposed by Engle (2002), and show that the t-DCC model passes the usual diagnostic tests based on probability integral transforms, but fails the value at risk (VaR) based diagnostics when applied to the post 2007 period that includes the recent financial crisis.

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Bibliographic Info

Paper provided by Faculty of Economics, University of Cambridge in its series Cambridge Working Papers in Economics with number 1025.

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Date of creation: 29 May 2010
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Handle: RePEc:cam:camdae:1025

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Web page: http://www.econ.cam.ac.uk/index.htm

Related research

Keywords: Volatilities and Correlations; Weekly Returns; Multivariate t; Financial Interdependence; VaR diagnostics; 2008 Stock Market Crash;

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Cited by:
  1. Natalia Bailey & Vanessa Smith & Hashem Pesaran, 2014. "A multiple testing approach to the regularisation of large sample correlation matrices," Cambridge Working Papers in Economics 1413, Faculty of Economics, University of Cambridge.
  2. Thomas Dimpfl & Robert Jung, 2011. "Financial market spillovers around the globe," Global Financial Markets Working Paper Series 20-2011, Friedrich-Schiller-University Jena.
  3. Pesaran, M.H., 2010. "Predictability of Asset Returns and the Efficient Market Hypothesis," Cambridge Working Papers in Economics 1033, Faculty of Economics, University of Cambridge.

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